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Thursday, February 28, 2008 12:38 PM


Fallacy of Inflation Targeting


Ben Bernanke is in favor of inflation targeting at 2% a year. Considering he means prices, he sure is a long ways off, at least as measured by the CPI or PPI.

But let's assume the Fed could magically meet that target. Inquiring minds might be wondering how that would look graphically. Let's take a look.

Inflation Targeting at 2% a Year



click on chart for sharper image.

The above chart is thanks to Minyan Charles who writes:

Hey Mish,

I have been pondering this whole "inflation-targeting" approach by the Fed. Their stated goal is around 2.0% year over year, correct? So, I did the graph I included which confirmed my suspicion that a constant percentage increase is indeed an exponential growth curve (who says bacterial growth is irrelevant for finances!). If the mandate is price stability, why would you shoot for an exponential growth situation? (And that is if you're doing your job well and hitting the target!)

Does stability really mean ever more increasing prices?!? When you combine this with the stagnant growth in wages over the last 30 years, it is easy to see why the middle class has been so squeezed. Why would deflation be so horrible, besides dispersing some wealth back to the have-nots? And did the Fed really kill inflation in the 1980s? Or did they just change the statistical reporting mechanisms?

Thanks,

Minyan Charles
Charles, thanks for that chart.
Let's see how the model actually stands the test of time.

CPI In Actual Practice




click on chart for sharper image
The above chart courtesy of the St. Louis Fed.

Note what happened once Nixon closed the gold window. Greenspan has maintained the Fed has approximated the gold standard in practice. The above chart proves otherwise.

Inflationistas Need Not Apply

No doubt inflationistas will be crowing about the above chart. Why shouldn't they? Then again Inquiring minds may wish to consider this progression.
Fallacy of Inflation Targeting

The reason banks (and government) want inflation targets is that inflation is beneficial to those with first access to money: banks, government, and the wealthy. By the time access to credit filters down to everyone, the economy is poised to reverse. This happens time and time again in every cycle. The current housing bust is the latest example.

Inflation Targeting and Price Stability Questions
  • Why should inflation be targeted at 2% and not 1% or 3%?
  • Why should any inflation be targeted at all?
  • Even if it was smart to target prices, can prices really be measured it accurately?
  • What do central banks do to overcome lag effects of monetary tightening and loosening?
  • Is this just blind faith "we know neutral when we see it"?
I addressed the above questions in Inflation Monster Captured. Inquiring minds may wish to take a look. If you have not yet seen it, there is a cute video from the ECB in the above link.

What it all boils down to however, is inflation targeting is nothing more than Fed sponsored theft to the detriment of those who obtain access to credit late in the cycle.

More importantly, the Fed can only succeed when attitudes allow the Fed to succeed. For more on attitudes please see Credit Lines Dry Up, Homeowners In Withdrawal.

Here is the pertinent snip:
Attitudes are like pendulums. Momentum carries both pendulums and attitudes to extremes. The pendulum of consumer recklessness has now reversed, having recently reached a secular peak. It will not stop at equilibrium on the way down. Instead, momentum will progress to a point of complete exhaustion marked by cautious saving instead of reckless spending.
For still more on attitudes please see "Social Mood Darkens", point 5 of Professor Depew's "Five Things" on How It's Gonna End.

According to Professor Depew, "Social mood drives social action, not the other way around. Cautious people cause home prices to plunge. Cautious businessmen cause credit to tighten. Fearful people suddenly view debt as harmful, not helpful."

In the final analysis the Fed undershoots, overshoots, and blows serial bubbles. It matters not whether this is by accident or design. The end result is the same: wealth concentration in the hands of the banks and the wealthy, fear sponsored government fascism, and the impoverishment of the middle class. For these reasons the Fed should be abolished.

Note that the inflation cycle ends when consumers are no longer willing or able to borrow, and banks are no longer willing or able to lend. The preponderance of data suggests that is precisely where we are now. The last time this happened the US was facing the great depression. There are now safety nets that may prevent a similar occurrence now, then again perhaps not. The real question is whether or not one is prepared.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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