by Shaun Richards
Today brings us a new variation on an old theme. This is the issue of what is the right level for an inflation target and sometimes we go as far as to whether there should be one at all? This begins with something of a fluke or happenstance. This is the reality that inflation targets are usually set at 2% per annum following the lead set by New Zealand back in the day. This has become something of a Holy Grail for central banksters in spite of the fact that it had no theoretical backing as this from the Riksbank of Sweden explains.
There was no relevant academic research from which to draw support; instead, the New Zealand authorities had to launch the new regime more or less as an “experiment” and quite simply see how well it worked in practice.
In fact it was as we see so often a case of trying to fit later theory to earlier practice.
This shows that it does not seem to be until the mid-1990s, i.e. about five years after its introduction in practice, that inflation targeting began to attract any significant interest in the academic research.
Basocally it was from a different world where inflation was higher and they wanted something of an anchor and an achievable objective.
Also there is another swerve as other time the central bankster preference for theory over reality has led to claims that it provides price stability when it does not. Let me illustrate from the European Central Bank or ECB.
The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.
The truth is in some ways in the “as defined” bit because if we return to the real world it simply isn’t. Also the inflation measure ignores owner-occupied housing an area where we often find inflation. It was relative price stability when inflation was higher but was never updated with the times leaving central bankers aping first world war generals and fighting the previous war.
What about now?
Here is CNBC from earlier this month.
Recent statements from Fed officials and analysis from market veterans and economists point to a move to “average inflation” targeting in which inflation above the central bank’s usual 2% target would be tolerated and even desired.
Actually then CNBC became refreshingly honest.
To achieve that goal, officials would pledge not to raise interest rates until both the inflation and employment targets are hit. With inflation now closer to 1% and the jobless rate higher than it’s been since the Great Depression, the likelihood is that the Fed could need years to hit its targets.
Not fully honest though because we only need to look back to yesterday and the Japanese experience which has gone on for (lost) decades. This theme was added to last week by an Economic Letter from the San Francisco Fed.
Average-inflation targeting is one approach policymakers could use to help address these challenges. Taking into account previous periods of below-target inflation, average-inflation targeting overshoots to bring the average rate back to target over time. If the public perceives it to be credible, average-inflation targeting can help solidify inflation expectations at the 2% inflation target by providing a better inflation anchor and thus maintain space for potential interest rate cuts. It importantly can help lessen the constraint from the effective lower bound in recessions by inducing policymakers to overshoot the inflation target and provide more accommodation in the future.
I have helped out by highlighting the bits which exhibit extreme Ivory Tower style thinking. In general people think inflation is under recorded and would be more sure of this id they knew that housing inflation is either ignored or in the case of the US fantasy rents which are never paid are used to estimate it. It turns into something the Arctic Monkeys dang about.
Fake tales of San Francisco
Echo through the room
Yesterday Bloomberg suggested such a policy was on its way but got itself in something of a mess.
But the Fed’s preferred measure of inflation has consistently fallen short, averaging just 1.4% since the target’s introduction.
The preferred measure PCE ( Personal Consumption Expenditure) was chosen because it gives a lower reading than the more commonly known CPI in the US. This is a familiar tactic by central banksters and if we add in the gap which is often around 0.4% we see things change. Next apparently things move in response to what the Fed is thinking as opposed to the interest-rate cuts, bond buying and credit easing.
“Rising inflation expectations are, in part, indicative of the market beginning to price in the Fed’s shift,” said Bill Merz, senior portfolio strategist and head of fixed-income research at U.S. Bank Wealth Management in Minneapolis.
Rising inflation expectations are presented as a good thing whereas back in the real world the old concept of “sticky wages” is back and in more than a few cases involves wage cuts.
There is an air of unreality about this which is extreme even for the Ivory Towers of economic theory. After all the last decade has given them everything they could dream of in terms of zero and sometimes negative interest-rates and bond buying on a scale they could not have even dreamt of. If we go back a decade they believed it would work and by that I mean hit the 2% inflation target and rescue the economy. But they have turned out to be the equivalent of snake-oil sales(wo)man where the next bottle will always cure you and even has “Drink Me” written on it in big friendly letters.
But it did not work and even worse like a poor general they left a flank open which is that by having no exit strategy they were exposed to any future downturn. So the Covid pandemic was unlucky in severity but not the event itself as something was always going to come along. To my mind the policy failure has been that central banksters got caught up in the here and now and forgot they had defined a fair bit of inflation away. So they did not realise the real choice was to lower the target to 1.5% or 1% or to put in a measure of housing inflation that represents inflation reality rather than a non-existent fantasy.
Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth Wind & Fire)
Thus they have ended up on a road to nowhere where in their land of confusion they have ended up financing government deficits. This rather than inflation targeting is the new role. Next up they look to support the economy but the truth is that we see another area where they have seen failure. Keynes explained that well I think in that you can shift expectations or trick people for a while but in the end Kelis was right.
Seen it in your one to many times
Said you might trick me once
I won’t let you trick me twice.
So whether they end up targeting average inflation or simply raise the target does not matter in the way it once did. The real issue now is getting politicians weaned off central banks financing their deficits for them. Good luck with that…….
The Investing Channel
by Shaun Richards