Capping Inflation Means Never Having to Say You're Sorry

Never admitting one's faults, also means not having to make amends for one's past mistakes. In particular, without a level target rule, central bankers don't need to explain to anyone why they may choose (via discretion) to withdraw aggregate spending capacity for any reason. Yet due to the way the Fed frames its communications processes, the public hardly understands what is at stake in their deliberations - nor is it easy to decipher what has actually been lost, since the Great Recession. On Milton Friedman's 90th birthday, Ben Bernanke made a surprising admission:

Regarding the Great Depression, you're right, we did it. We're very sorry. But thanks to you, we won't do it again.

Scott Sumner must have remembered this astonishing moment of honesty on Bernanke's part, in a recent monetary conference, when he mused: why, if apologies were in order for that earlier calamity, is admitting fault for the Great Recession still off the table? Granted, Bernanke and company did what they believed was necessary to rescue the financial system, and even congratulated themselves in the process. Ah well, when it comes to expecting inflation targeting to guide monetary policy, perhaps an arbitrary cap is simply Fed "toughlove" which means never having to say you're sorry.

Or perhaps the moral hazards of inflation targeting have yet to be publicly emphasized, because so much of economic debate remains "above the fray" in this regard. Yet without this perspective, it can be a bit of a struggle to explain the importance of a level nominal target to others, so as to reinforce one's points at an emotional level. Greg Ip's incisive questions for the last panel (well after an extended lunch!) at the "Monetary Rules for a Post-Crisis World" conference, was a case in point. Hence I agree with Bonnie Carr, that emphasizing the moral hazards of inflation targeting, may be a good tactic, especially now. In a recent post, she asks:

Why is it imperative, above all else to keep inflation low and stable rather than being allowed to reasonably drift with supply side conditions?...If headline inflation is nearly always a supply side phenomenon, what effect does it have to effectively cap pricing pressures as a matter of policy?...Don't those pressures have to go somewhere?

Indeed they do. Given that services (of non tradable sectors) are a larger component of developed economies than tradable sectors, inflation targeting has reached a point where it could be distorting the production potential of marketplace structure.

After all, remember what resides below a hard inflation cap. The relative inflation of non tradable sectors leaves less room for tradable sector formation. Think of this as expensive necessities versus "cheap" everything else. Yet the consequent lack of growth in tradable sectors, means less redistributed revenue remains available for service sector formation. As secondary markets, service sectors must rely on the very tradable sector wealth which their relative inflation continues to suppress. This state of affairs likely contributes to what has now become the slowest services growth in six years.

David Beckworth also pointed out in the above mentioned Mercatus conference that with a level target rule, the Fed would be formally committed to take care of past mistakes. Even though the Fed has become fairly consistent in representing aggregate spending capacity since the Great Recession, no one can really discern how those earlier monetary and production losses impacted output and growth potential. And because of inflation targeting framing, many still do not recognize how or why, so many of these losses took place.

According to Scott Sumner:

It is NGDP growth shocks that destabilize labor markets and financial markets, not inflation shocks...

He also responded to a recent claim from Michael Hatcher, that NGDP targeting is "confusing":

The public would actually find it much easier to understand NGDP targeting whereas the public is completely mystified by inflation targeting...When the public thinks about "inflation" they tend to implicitly hold their nominal income constant. Thus they wrongly think that inflation lowers their living standard...But of course the Fed has no impact on supply side inflation, it can only influence demand-side inflation.

What I find especially significant about Scott's remarks, is what the public mistakenly believes as to income already being held constant. Without the appropriate framing of nominal income or aggregate spending capacity for this discussion, it is only more difficult to deal with the fact that policy makers remain uncertain as to human contribution to economic activity in the near future. Because of the language of inflation targeting, people have few means by which to engage in the most important economic debate of our time: keeping citizens front and center, in both monetary representation and economic reality.