Bloomberg printed an excerpt from the upcoming book “Keeping At It: The Quest for Sound Money and Good Government,” by Paul Volcker. But I am not sure that excepting it afforded the justice it likely deserves because, as is, it disappointingly leaves more questions than answers.
For example, it says:
In 1996, Federal Reserve Chairman Alan Greenspan had an exchange with Janet Yellen, then a member of the Fed’s Board of Governors, that presaged a major — and, I think, ill-advised — change in the central bank’s approach to managing the economy. Yellen asked Greenspan: “How do you define price stability?” He gave what I see as the only sensible answer: “That state in which expected changes in the general price level do not effectively alter business or household decisions.” Yellen persisted: “Could you please put a number on that?”
Since then, under the chairmanship of Ben Bernanke and then under Yellen, Alan’s general principle — to me entirely appropriate — has been translated into a number: 2 percent. And more recently, a remarkable consensus has developed among central bankers that there’s a new “red line” for policy: A 2 percent rate of increase in some carefully designed consumer price index is acceptable, even desirable, and at the same time provides a limit.
I puzzle about the rationale. A 2 percent target, or limit, was not in my textbooks years ago. I know of no theoretical justification. It’s difficult to be both a target and a limit at the same time. And a 2 percent inflation rate, successfully maintained, would mean the price level doubles in little more than a generation.
Then Volcker goes on to discuss inability to be precise partly due to the index itself and things that go on in the world that may cause a rise in inflation. I was whole heartedly following this excerpt by this point, about 5 paraphs in, thinking he was stepping in to make the same argument I’ve made here over the years that IT probably isn’t such a great idea only in a much better way.
But then it takes a quite disappointing and puzzling turn, accusing people like me of deflation fear for objecting to the 2% inflation ceiling folly, sort of waving off the concern over sticky wages, disinflations and nominal debt contracts, as if it happened once in a “serious” way 80 years ago and can’t happen again, while the stubborn fact of what happened to the PCE in 2008-09 is supposedly not serious and caused by bad banks anyway.
But it is also true, and herein lies the danger, that such seeming numerical precision suggests it is possible to fine-tune policy with more flexible targeting as conditions change. Perhaps an increase to 3 percent to provide a slight stimulus if the economy seems too sluggish? And, if 3 percent isn’t enough, why not 4 percent?
The fact is, even if it would be desirable, the tools of monetary and fiscal policy simply don’t permit that degree of precision. Yielding to the temptation to “test the waters” can only undercut the commitment to stability that sound monetary policy requires.
The old belief that a little inflation is a good thing for employment, preached long ago by some of my own Harvard professors, lingers on even though Nobel Prize–winning research and experience over decades suggests otherwise. In its new, more sophisticated form it seems to be fear of deflation that drives the argument.
Deflation, defined as a significant decline in prices, is indeed a serious matter if extended over time. It has not been a reality in this country for more than eighty years.
It is true that interest rates can’t fall significantly below zero in nominal terms. So, the argument runs, let’s keep “a little inflation” — even in a recession — as a kind of safeguard, a backdoor way of keeping “real” interest rates negative. Consumers will then have an incentive to buy today what might cost more tomorrow; borrowers will be enticed to borrow at zero or low interest rates, to invest before prices rise further.
All these arguments seem to me to have little empirical support. Yet fear of deflation seems to have become common among officials and commentators alike. (Even back in July 1984, as my Fed colleagues and I were still monitoring the 4 percent inflation rate, the New York Times had a front-page story warning about potential deflation.) Actual deflation is rare. Yet that fear can, in fact, easily lead to policies that inadvertently increase the risk.
IT cannot offer stability because of the lack of precision in measurement as Volcker point out here, but also in lack of extraction of supply side noise, and these become even more problematic with a low value target that leaves no room for error as conditions deteriorate.
If that non-serious version of PCE disinflation and deflation in 2008-09 didn’t violate the Greenspan principle and didn’t influence people’s decisions about what they did with their money or have something of an impact on banks’ balance sheets given everything we know about debt and deflation, and sticky wages and deflation, I suppose I am quite at a loss for words to explain what all the fuss over the Great Recession, bankruptcies and hoarding was all about. Perhaps it was just another day at the office. It’s just really a shame that scores of millions of people, including me, ended up with no longer having an office to drag themselves to every morning when we can’t seem to pin the blame on the people who claim to control inflation and inexplicably and slavishly serve the 2% target as a holy grail yet fall short, as questions involving its appropriateness go unanswered and the force with which it is applied remains unjustified.
And since I’ve been around quite longer than I would ever admit in public, and I understand MV=PY, that disinflation/deflation experience serves as a reminder that a doubling of the nominal price level in a little more than a generation or maybe even a little faster because all prices nominally double is probably not the very worst that could happen, unless one stuffs their mattress with cheesy greenbacks all their life (doesn’t everyone?). I’ve lived through both conditions and in deciding which condition best meets the Friedman principle of leaving everyone better off there is not even a contest.
Coming from a guy whose namesake Fed ran inflation between 3% and 5% after taming the 1970’s fiasco, all this seems like selective memory if running it at the apocalyptic level of 3% is what causes recessions. Really? Then who is ultimately to blame for the Great Recession? He can’t have it both ways. Sorry.