Mo' Money

Good in theory. . .

Setting a specific goal for inflation could be a better way of controlling expectations about future price changes and help make the U.S. economy more efficient, Federal Reserve Board Governor Ben Bernanke said.

In an interview posted on the Minneapolis Federal Reserve Bank’s Web site earlier this week, Bernanke — a vocal advocate of targeting inflation — said that, while the Fed’s inflation- fighting credibility is high, the adoption of a numerical goal could still prove helpful.

“Inflation expectations in the United States are better anchored then they used to be, but are still too volatile for optimum performance of the economy,” he said.

. . . but bad in practice?

Fighting inflation is a worthy goal — and something the Fed has gotten good at only in the last 20 years or so in its 80-year history. But I have a problem with the Fed setting a target number.

Problem is, the way the CPI (consumer price index) is figured, it almost certainly overstates inflation. There are a number or reasons for this, none of which I have time to go into today, so you’ll just have to take my word for it.

(Or head over to Asymmetrical Information and run a search for CPI. I’m pretty sure Jane did a good piece on it a couple years ago.)

Anyway. If the Fed wants to target a particular number, they will A) never hit it, and; B) the number will be imaginary, anyway. Kind of like shooting at an optical illusion firing a rifle with a bad scope. Net result? The Fed would lose some of its current flexibility, and we’d suffer from a too-tight monetary policy.