Fed Readying Inflation Target Strategy- Will It Matter?

Rumor is abuzz this week as Federal Reserve chairman Ben “Helicopter” Bernanke may be ready to announce a strategy of specific inflation targeting to boost the market’s confidence in the central bank.  From Reuters:

The Federal Reserve could take the historic step this week of announcing an explicit target for inflation, a move that would fulfill a multi-year quest of the central bank’s chairman, Ben Bernanke.

An inflation target would be the capstone of Bernanke’s crusade to improve the Fed’s communications, an initiative aimed at making the central bank more effective at controlling growth and inflation. It would, at long last, bring the Fed into line with a policy framework used by most other major central banks.

For decades, the unofficial inflation target of the Fed has been 2%.  The 2% rate isn’t the rate calculated as the Consumer Price Index but the “core” rate which excludes volatile prices such as food and energy.   What Bernanke appears to be doing is setting the stage for further rounds of explicit bond purchasing sometime down the road if inflation should fall  short of the newly established target.

Inflation targeting however presumes the Fed is capable of reaching an exact target that is only ever dictated by the billions of actions committed by market actors.  Central banks can only ever flood the monetary system with newly created funds, they can’t force banks to lend by creating credit out of thin air.

The idea that inflation can somehow be targeted to an exact degree is pure central planning fantasy.  Like Hayek wrote in The Use of Knowledge in Society:

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.

But of course inflation targeting also presumes that inflation in itself is a good and necessary thing for economic growth. Yet historical evidence shows that growing economies which experience robust increases their productive capacity and general living standards are marked by falling prices.  Falling prices of course lead to raises of wages in real terms.  The real, more insidious purpose of monetary inflation was revealed in Keynes’ General Theory:

“the escape will be normally found in changing the monetary standard or the monetary system so as to raise the quantity of money, rather than forcing down the wage-unit and thereby increasing the burden of debt.”

When Keynes refers to escape, he is speaking on the best means to put an end to recessionary conditions.  Like central bankers who celebrate inflation targeting as some great tool to further their dominance over an already overly regulated economy, Keynes ignores any unintended consequences of credit expansion or Cantillon effects which distort prices and wages heterogeneously as newly created money makes it way across the market spectrum.  Inflation is treated as solution with immediate effect that doesn’t take time to fully pan out.  It’s true purpose is to clear the labor market by raising prices and thus lowering real wages without inducing outrage over a nominal effect.  Keynesians assume Joe the Assemblyman is a neanderthal too ignorant to realize he is being duped by prices rising all around him and his paycheck, though still the same numerical amount as last year’s, falling in real terms.

While a nice gesture in transparency, the Fed’s potential new inflation target strategy will likely have little effect unless the newly established target is something radically different than the unofficial rate of 2%.  Bernanke will still print his way out of any disaster, come hell or high water.  And by hell or high water, I mean the next speculative burst caused by cheap money invariably finding its way into another bubble.

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