Target folly

There is an article posted on Bloomberg today about what the release of the CPI measures that is expected later today may mean for the Fed. And it quotes some Fed officials providing alternate definitions of flexible inflation targeting:

“I do think there are some special one-time, transitory factors, these unusual changes reflecting the move to unlimited data plans for cell phones, and the large declines in some prescription drug prices,” Yellen said in Senate testimony on Thursday. “There may be more going on. We’re watching inflation very carefully in light of low readings.”

Chicago Fed President Charles Evans, for his part, posited that technological changes to the competitive landscape — best evidenced by the rise of e-commerce giant Amazon.com Inc. — may be suppressing inflation by leaving businesses less able to raise selling prices even in the face of increasing labor costs.

It goes on to say that Yellen believes that yoy inflation measures distort the inflation landscape. Add to this the point Evans made that Amazon is now so large as to keep inflation down.

Aside from the fact that Evans appears to now agree with me that the supply side is global, this does not appear to me as a reasonable explanation (or excuse) for the Fed missing its target. Amazon activity is supply side deflation, a variable that is mostly real. The Fed’s target is nominal.

It’s true that the central bank should not react to price changes related to supply side factors, but there is there isn’t any press coverage of discussion of how to disentangle real factors from nominal that are aggregated within the popular inflation indices that would allow us to be able to tell approximately whether the Fed is doing or has already done too much “normalization; and certainly the Fed’s bias toward tight creates a degree of risk of unnecessary negative outcomes for many.

This situation is a ripe environment for picking the inflation target approach to policy apart because what we are being told in this article at the most basic level is that the Fed is BLIND with respect to the target.

  • Interest rates are unhelpful in judging whether policy is loose, neutral or tight. The natural rate is unobservable.
  • Inflation measures are bias toward overstatement of price changes that include both real and nominal variables that are impossible to disentangle for an accurate view of policy stance, increasing the likelihood of ongoing policy error, and additional over parsing of the data delays appropriate policy responses.
  • Given the Fed’s behavioral bias toward tight, the most likely outcome is premature death of an expansion in the form of a negative nominal shock and unnecessary recession.

If these are the kind of excuses for ongoing undershooting of the target we are going to be seeing, excuses that logically point to more of a religious adherence to a target that has as many possible interpretations as there are opinions about it as opposed to rational and methodical policy management, Congressional leaders need to press the issue for accountability much harder and at lightning speed. We can’t count on the supposed “smart” people at the Fed to realize their own folly and to stop hurting far more than they help, and they need to be held to account for their choices that are clearly damaging.

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