That move by our central bank was years in the making. There is a book called Inflation Targeting, published in 1999, co-written by former Federal Reserve Chair Ben Bernanke (who ran our central bank in January 2012) along with three others, and it not only provided their rationale for the idea, but also inadvertently answered why inflation targeting would fail in both Europe and America.
“The strongest argument for inflation targeting,” the book argues, “is that it can help to provide monetary policy with what economists call a ‘nominal anchor’” – the inflation target and the promise to meet it. Combined with the use of “clear and timely communication of policy objectives, plans, and tactics to the public,” inflation targeting will assure the “public comes to expect the central bank will act strongly to resist inflationary pressures.”
Despite labeling the inflation targets as a “nominal anchor” the authors also paradoxically believe that, “in real-life monetary policy…only discretion prevails.” Embracing this contradiction, the authors repeatedly extol how “flexible” inflation targeting is in actual practice. In fact, the ‘nominal anchor’ is anything but as the central bank may “implement changes in target values and time horizons when such changes appeared necessary.” The Fed has already moved to a “flexible average inflation target” policy as of August 2020.
In addition to this power to change the inflation target, the manner of how to measure inflation targeting’s success by the use of price indices introduces other obstacles. Besides inflation indexes being backward looking, they are also ever-shifting things, always elusive and subjective, making accuracy impossible. John Maynard Keynes once cautioned on their use due to “the well-known, but unavoidable, element of vagueness which admittedly attends the very concept of the general price-level makes this term very unsatisfactory for the purposes of causal analysis, which ought to be exact”. Under an inflation targeting regime, the anchors are poorly measured and adrift on the tides of discretion.
Ultimately, though, it is the fatal economic flaw in the theory expressed in Inflation Targeting that condemned it; the authors’ belief that inflation is not a monetary phenomenon. If Bernanke and his co-authors believe otherwise, they do a strangely thorough job of hiding it. After reading this book one could be forgiven to think inflation is caused by wages, economic growth, oil, “inflation expectations”, taxes and/or a general level of prices that just seems to rise of its own accord. The authors believe that, “Inflation is, after all, determined by the interaction of many forces”.
Growth in the monetary aggregates, though, is not one of them as it has “only an indirect and statistically uncertain relationship to ultimate goal variables, such as inflation”, so the better approach is to “downgrade the attention to monetary aggregates and put inflation targets at the forefront instead”. They take this position despite their admission elsewhere that “monetary policy is the most direct determinant of inflation” and “in the long run, the inflation rate is the only macroeconomic variable that monetary policy can affect.” And what does monetary policy do if not increase or decrease the availability of money?
They also add that “because of the breakdown of the relationship between monetary aggregates and nominal spending and inflation”, watching money supply growth is “obsolete.” However, Bernanke’s Macroeconomics textbook, released one year prior to Inflation Targeting, took the exact opposite position - that inflation is determined by growth in nominal money supply and real money demand. He continued “in countries with high inflation, however, the growth of the nominal money supply usually is the much more important of these two factors”.
Inflation targeting, by keeping a sharp eye on everything but the money supply that is the actual source of inflation, was bound to fail to control it - but this failure is not an unwelcome outcome to many people. For all our praise of and publicly stated wish for “stable prices” it’s something we as a nation simply don’t want. On the subject of inflation America has met the enemy and he is us; human nature being what it is, a profligate, heavily indebted people will be no other way.
And therein lies the rub, so to speak, what the authors of Inflation Targeting correctly point out as another particular danger in American-style central banking - “the unavoidably political nature of a central bank’s accountability under any democratic system.” When a democracy is combined with a central bank, a people are granted not only the government they deserve, but also the monetary policy they desire.
If you think me too harsh I ask -- who of any consequence is calling for the Federal Reserve to allow prices to fall? The very idea would be greeted with fear and derision. So sometimes faster and sometimes slower, inflation it has been and always shall be. One of our grumpier founders (named Fisher Ames) once asked, “Is it possible the people should ever be their own enemies?” The cynic in me says most certainly, and I offer America’s unshakable love of inflation as proof of the accusation.
