by Mitch Kokai
Senior Political Analyst, John Locke Foundation
The idea of an inflation target was established in January 2012, in the aftermath of the 2008-09 financial and economic crisis. The Fed said then that an explicit goal would help promote the central bank’s dual mandate: low unemployment consistent with stable prices. And in those tough postcrisis years, the extraordinary easy monetary policy succored an economy flat on its back.
Despite the Fed’s assiduous ministrations, however, inflation has stubbornly resisted the 2% target for most of the past five years. The 12-month change in the consumer-price index was a tame 1.7% in July, down from a more than 2% run rate earlier in the year.
There are two downsides to the Fed’s unrelenting—if as yet unsuccessful—pursuit of a specific inflation target. First, the central bank’s credibility is at risk, notes economist A. Gary Schilling. “If you say you have the monetary tools to effect that target, and you don’t, then one has to question their tools,” he says.
Schilling, who advocates eliminating the target, wonders “why the Fed is in the inflation-forecasting game at all,” given its poor record at forecasting, whether it’s gross domestic product or inflation. “[Dropping] it would be a jolt, but the Fed would end up with more credibility.” …
… The other problem with targeting rather than maintaining a flexible response, which was the case before 2012, is the risk that the Fed “keeps policy too easy for too long,” says Mike O’Rourke, chief market strategist at JonesTrading.
The country has had price stability for five years, but to gain a few basis points more of inflation, the Fed has pursued an easy policy for an extended period of time, potentially inflating a bubble in financial assets, he says.