Papa Ben Bernanke rolled out his inflation targets last week. In the guise of increasing "transparency," forecasts were welcomed for GDP, core inflation, headline inflation and employment. The exercise establishes de facto inflation targets, long a Bernanke objective.
Barney Frank, chair of the House Financial Services Committee, is a long-time critic of inflation targeting. Frank feels the Fed is worrying too much about inflation and not enough about income inequality.
"We are at the situation where distribution of wealth has become a significant economic issue."
In an interview in February, Frank told the Financial Times that Bernanke
"has a statutory mandate for stable prices AND low unemployment. If you target one of them and not the other, it seems to me that will be inevitably be favored."
Inflation is inevitable with the falling dollar and its flip side, rising oil and other import prices. Targeting inflation is not a good idea, because the only prices the Fed can control are those for labor. Depressing wages only depresses demand and slows the economy.
Transparency may be a smokescreen, according to Frank.
"When you make it more transparent, you enhance its importance.... But when you make it public, you lose flexibility."
Do the Fed forecasts really constitute a target?
In the words of Marvin Goodfriend, a Bernanke protege and former Fed staffer.
(November 15, Bloomberg):
"...Insofar as inflation forecasts go, as you lengthen the horizon the Fed ought to be able to manage inflation. That is, you can target inflation over the long run. That’s the nature of what Monetary Economics teaches us, that Central Banks determine the rate of inflation over the longer run. So the longer the horizons are, the more these forecasts turn into targets for the Federal Reserve to aim at.
"On the other hand, the longer the forecast horizons are, the more difficult it is to forecast the real GDP numbers and the unemployment, over which the Federal Reserve has less control over the longer run."
Bernanke himself has said
"... In all but the shortest of terms the Federal Reserve’s policy determines how much inflation there is, and we’re going to make sure that the inflationary impact that may come from the weakening dollar is not passed into broader prices and become part of the underlying inflation rate."
The hubris is chilling.
Bernanke is not encumbered by concern for the real world. A practicing economist who spoke to the point was Carl Weinberg, chief economist at High Frequency Economics (November 20, Bloomberg’s "On the Economy with Tom Keene).
"... The Fed is out to control the things it can control. When it comes to goods and services, things that are controlled by labor costs, the Fed is in there keeping an eye on it. It doesn’t mean headline inflation isn’t important, but it means that in terms of the Fed monitoring things in terms of what it can do, I think core inflation is probably the place to look.
"Something else to think about is when you see food prices go up, or you see energy prices go up, that’s not inflation. That’s a relative price change. And in fact, the analysis is very different when you see the price of food go up relative to the price of everything else, because it squeezes out consumption of other things and is actually a depressing impact on the economy as long as we don’t have wage increases to offset those food price increases. So generally speaking a rise in food prices brakes the economy by itself. A rise in energy prices brakes the economy as long as other prices are under control."
The falling dollar will inevitably lead to inflation. Imports of goods from countries who do not manipulate their currency will increase in price. Imports of commodities like oil, natural gas and metals will increase in price. Domestic goods and services, particularly farm products, that have export markets will increase in price because they will be bid up by overseas consumers. The dollar has been falling for years and has picked up recently with the credit market fiasco, as investors flee housing and rush into currencies and commodities.
The underlying dynamic has little to do with the current mess in the markets and everything to do with the imbalance in trade that has been maintained over the past thirty years. Standard economic theory says exchange rates are supposed to adjust to balance trade in goods. Instead the world has been willing to accept greenbacks as "reserve currency," that is, as valuable in themselves.
This weakening dollar inflation will push up prices because it pushes up costs of goods as measured in dollars. This is the so-called "cost-push" inflation. Bernanke and the Fed do not distinguish between types of inflation. They will manipulate the rate higher to reduce demand pressure by increasing unemployment and keeping down wages. The interest rate is the only tool they recognize, and it only works for "demand-pull" inflation, where too much money is bidding up prices and wages and creating boom conditions as everybody tries to produce earlier before prices rise, then sell into the rising markets.
"Core inflation" is a term for inflation minus food and fuel. This is the Fed's target. It is a proxy for compensation to employees, and so when it is depressed, wages are depressed and demand is depressed. (Recall Weinberg's comments.) When the Fed targets core inflation, it is putting the brakes on a stalling economy.
When the Fed talks about "price stability," it is not talking about stability, but about keeping down the volatility of inflation. Volatility is not the same thing as instability. The stable thing to do would be to recognize the inevitable, and even desirable return of the exchange rate mechanism and to encourage an orderly return to an international scheme of trading goods for goods instead goods for little green pictures of men in powdered wigs.
The price of labor should rise in concert with the rise in the prices of other goods. That is, "core inflation" should keep pace with headline inflation. The thought that this will lead to spiraling inflation, as first goods, then wages, then goods, then wages rise, is a misreading of the situation. But worse is the Fed's contention that its discipline with monetary policy will do something other than punish the rest of us. The Fed should just put down its toy and do something constructive, like regulating and practicing its discipline on the out-of-control financial sector before it runs us all into the ground.