Mishkin: “In Praise of an Explicit Number for Inflation”

Frederic Mishkin argues that the Fed needs to adopt an explicit inflation target since this would help to insulate against the threat of deflation:

In praise of an explicit number for inflation, by Frederic Mishkin, Commentary, Financial Times: Many central banks throughout the world have adopted an explicit, numerical … inflation target. The US Federal Reserve is currently not one of them, but it is discussing this possibility. In the current circumstances with the economy in freefall, is … an increased commitment to stabilising inflation the right thing to do…? My answer is absolutely yes. Adopting an explicit, numerical inflation objective is exactly what is needed right now to help the US economy to recover.

The usual argument for establishing a transparent and credible commitment to a specific numerical inflation objective is that it provides a firm anchor for long-run inflation expectations, thereby directly contributing to the objective of low and stable inflation. … However, not as well recognised is that an inflation target can help prevent inflation from falling too low. At this critical juncture that benefit can have enormous value. …

The danger right now is not that inflation expectations will … become unanchored in the negative direction. Indeed,… if they fall further they could lead to two dangerous consequences.

First, there would be an increased likelihood inflation would become persistently negative: that is deflation. Experiences of deflation in the Great Depression and the “lost decade” in Japan suggest it causes great hardship. Second, with the federal funds rate near zero and therefore unable to go lower, persistent deflation would raise the effective cost of borrowing to households… Despite an interest rate of zero, monetary policy would become highly contractionary.

How would adopting an explicit numerical inflation objective help? First, a commitment … would provide … incentives for the Fed … to stick to its word and … make monetary policy sufficiently expansionary in the future. Research has shown a lack of such commitment was one reason why unconventional monetary policy actions such as quantitative easing by the Bank of Japan were ineffective…

Second, when the financial system starts to recover, to keep future inflation under control the Federal Reserve will need to drain the massive amounts of liquidity it has pushed into the financial system… A commitment to an explicit numerical inflation objective would … subject the Fed to public pressure if it was not taking the necessary steps to make this happen.

Critics of inflation targeting fear adoption of an explicit numerical inflation objective might lead to too little focus on stabilising economic activity. …That is why the term “inflation targeting” is somewhat of a misnomer because it does not mean the central bank should try to hit the target over a fixed horizon…. In addition, an explicit numerical inflation objective by the Federal Reserve would be adopted only if it was consistent with the dual mandate … of both price stability and stability of economic activity.


Originally published at the Economist’s View reproduced here with the author’s permission.

2 Responses to "Mishkin: “In Praise of an Explicit Number for Inflation”"

  1. Guest   January 13, 2009 at 8:14 am

    As a contribution to the current debate, this suggestion is welcome and worthy of strong consideration.However, the tools to ensure a moderate, positive inflation rate do not credibly and identifiably exist under an inflation targeting framework, under conditions of deflation, when the zero-bound has been reached.Moreover, under deflation, faling prices are the undesirable side effect, rather than the core problem. More traditionally for a central bank, the risk of unacceptably rising prices is the core problem.An inflation target during deflation also risks focusing too much on the means rather than the ends.Ultimately I believe the proposed policy could be helpful, as long as it is not front and center and does not purport to promise too much.sincerely,Richard Segal

  2. flow5   January 16, 2009 at 10:46 am

    First, there is no ambiguity in forecasts: In contradistinction to Bernanke (and using his terminology), forecasts are mathematically “precise” :(1) nominal GDP is measured by monetary flows (MVt);2) Income velocity is a contrived figure (fabricated); it’s the transactions velocity (bank debits, demand deposit turnover) that matters;(3) “money” is the measure of liquidity; &(4) the rates-of-change (roc’s) used by the Fed are specious (always at an annualized rate; which never coincides with an economic lag). The Fed’s technical staff, et al., has learned their catechisms;Friedman became famous using only half the equation (the means-of-payment money supply), leaving his believers with the labor of Sisyphus.Contrary to all economists, the lags for monetary flows (MVt), i.e. proxies for (1) real-GDP and the (2) deflator are exact, unvarying – respectively.Roc’s in (MVt) are always measured with the same length of time as the specific economic lag (as its influence approaches its maximum impact; as demonstrated by a scatter plot diagram).Not surprisingly, adjusted member commercial bank “free/gratis” legal reserves (their roc’s) corroborate/mirror, both lags for monetary flows (MVt) –– their lengths, or frequency, are identical — (as the weighted arithmetic average of reserve ratios remains constant)The lags for both monetary flows (MVt) & “free/gratis” legal reserves are synchronous or indistinguishable. Consequently, economic forecast are mathematically infallable (which includs housing bubbles, commodity bubbles, etc.).This is the “Holy Grail” & it is inviolate & sacrosanct.The BEA uses quarterly accounting periods for real GDP and deflator. The accounting periods for GDP should correspond to the economic lag, not quarterly.Monetary policy objectives should not be in terms of any particular rate or range of growth of any monetary aggregate. Rather, policy should be formulated in terms of desired roc’s in monetary flows (MVt) relative to roc’s in real GDP.Note: roc’s in nominal GDP can serve as a proxy figure for roc’s in all transactions. Roc’s in real GDP have to be used, of course, as a policy standard.Because of monopoly elements, and other structural defects, which raise costs, and prices, unnecessarily, and inhibit downward price flexibility in our markets, it is probably advisable to follow a monetary policy which will permit the roc in monetary flows to exceed the roc in real GDP by c. 2 – 3 percentage points.In other words, some inflation is inevitable given our present market structure and the commitment of the federal government to hold unemployment rates at tolerable levels.Some people prefer the devil theory of inflation: “It’s all Peak Oil’s fault.” This approach ignores the fact that the evidence of inflation, is represented by “actual” prices in the marketplace.The “administered” prices of the world’s oil producing countries would not be the “asked” prices were they not “validated” by (MVt), i.e., validated by the world’s Central Banks ( i.e., as Friedman maintained “inflation is always and everywhere a monetary phenomenon”)