Fed Has Never Pursued Price Stability
Greg Mankiw argues that the Fed should abandon price stability and instead pursue inflation. He specifically calls for a target of a 30% increase in the CPI over the next 10 year, which he claims would represent a radical shift in policy.
The problem with this reasoning is that the Fed has never pursued price stability in the sense he appears to use the word, which is to say zero inflation. In fact, if you look at the data, you can see that during the last 10 years (November 1998 to November 2008), the CPI rose in fact by 29.5% (the index rose from 164.0 to 212.425), almost exactly as much as Mankiw wants the Fed to target. And if you only look at the latest 5 years (November 2003 to November 2008), the increase was 15.1% (the index rose from 184.5 to 212.425), which would be 32.6% if repeated during the coming 5 years.
In other words, the Fed has already for years pursued the very policy which Mankiw claims would solve the problems. And given the fact that the Fed has created the kind of inflation rates Mankiw wants and given the fact that they have never pledged to pursue any other inflation rate, these inflation rates should already be expected.
To the extent that skepticism about the Fed's ability to create inflation has lowered these expectations, explicit targets shouldn't make any difference.
The problem with this reasoning is that the Fed has never pursued price stability in the sense he appears to use the word, which is to say zero inflation. In fact, if you look at the data, you can see that during the last 10 years (November 1998 to November 2008), the CPI rose in fact by 29.5% (the index rose from 164.0 to 212.425), almost exactly as much as Mankiw wants the Fed to target. And if you only look at the latest 5 years (November 2003 to November 2008), the increase was 15.1% (the index rose from 184.5 to 212.425), which would be 32.6% if repeated during the coming 5 years.
In other words, the Fed has already for years pursued the very policy which Mankiw claims would solve the problems. And given the fact that the Fed has created the kind of inflation rates Mankiw wants and given the fact that they have never pledged to pursue any other inflation rate, these inflation rates should already be expected.
To the extent that skepticism about the Fed's ability to create inflation has lowered these expectations, explicit targets shouldn't make any difference.
posted by stefankarlsson at 5:58 PM
4 Comments:
To be fair Mankiw does admit that the fed has never adopted a price stability model, only verbiage.
"The next step for the Fed is to drop the "price stability" rhetoric"
"The Fed has never been truly committed to stable prices. After all, inflation during the Volcker-Greenspan era averaged about 2 to 3 percent."
You're right, he does write that. But his reasoning only makes sense if you assume that price stability is interpreted as zero inflation, and price stability can in fact be interpreted as 2 to 3% inflation (in fact, since "stability" is a relative term it could be interpreted as 10% inflation, which would be stability compared to Zimbabwe-style hyperinflation). This is similar to how few would interpret the "full employment" target as a 0.0% unemployment rate, but rather something more like 4 to 5%.
Given the historical track record and the failure to specify what price stability means, the most logical interpretation of what the Fed means by price stability would be 2 to 3% inflation, which in other words mean no difference at all compared to Mankiw's suggested target.
"In other words, the Fed has already for years pursued the very policy which Mankiw claims would solve the problems."
What is funny is that Mankiw effectively does claim that the cause of the problems is the solution. Maybe he adheres to some strange rational-expectation theory that claims that any inflation/monetary policy is good as long as it's 'stable'? And thus continuation of Fed policy is good? Maybe he will even go as far to claim that, yes, stabilization is chaos, but it is still stable?
Arend
It makes sense now in that a Harvard Professor is making such nonsense of himself. It makes sense because now I understand why we got into this mess. Obviously, having a Harvard degree isn't worth much if this is the quality of teaching/ideas they flaunt over there.
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