Within the Federal Reserve sometime in 1996, a discussion took place among FOMC (Federal Open Market Committee) members regarding the subject of inflation targeting. Federal Reserve District Governor (San Francisco) Janet Yellen believed that a little inflation “greases the wheels” of the labor market. Her preferred “target” was 2%. She asked Chairman (at the time) Alan Greenspan his preference.
The Chairman replied. “I would say the number is zero, if inflation is properly measured.”
On the surface, it might seem that Chairman Greenspan is indicating that no inflation is preferable to “a little” inflation. But that is contradictory to the actual mechanics of ongoing monetary action by the Fed since its inception in 1913.
The Federal Reserve creates inflation through ongoing expansion of the supply of money and credit. Our fractional-reserve banking system is intrinsically inflationary – at the very least. And what did he mean by the parenthetical comment, “if inflation is properly measured”.
More likely, he was adopting the role of devil’s advocate and trying to promote further, active discussion among FOMC members. The results seem to indicate this.
In meetings the next day, Greenspan summarized the discussion: “We have now all agreed on 2 percent.” The Federal Reserve now had an internally stated, unofficial inflation target. Their own “guiding light”. But they didn’t want to talk about it publicly. At least Greenspan didn’t.
He termed their discussion “highly confidential (in) nature” and said: “I will tell you that if the 2 percent inflation figure gets out of this room, its going to create more problems for us than I think any of you might anticipate.”
Ben Bernanke didn’t share Greenspan’s reservations. He wanted everyone to know that the Fed’s inflation target was 2%. But why?
One possibility is the need for justification.
Actions by the Federal Reserve are historically unclear as to logic and purpose. That allows for a modicum of privacy and the false descriptive of an independent Fed. It also suggests an aura of ‘special dispensation’ surrounding the Fed.
By late 2010, however, those notions were unravelling quickly as people wallowed in the after effects of the financial crises of 2007-08. Mr. Bernanke and his fellow practitioners of monetary medicine were seen as ineffective, at best, and appeared as if they did not know what they were doing.
Action was, in effect, demanded. And they were not afraid to pull the trigger. But they needed a clear, publicly observable target. How does anyone know you hit the target if they don’t know what you are aiming at?
Having a clearly acknowledged target changes the focus. Judgment is restricted to the new area of focus. Did you hit the target or didn’t you?
This presumes that the target is justified, of course. And if an inflation target is justified, why 2%? Why not a lower number? Or any other number? In truth, it probably doesn’t make any difference.
From the Fed’s perspective, it gives them a license to openly discharge their firearms in the public square. If they miss, they can just reload and fire again.
Should they happen to hit the target, they can either maintain their current posture, or tweak it accordingly so as not to overshoot in the future.
But they will never “hit” their target. Especially this one. Why not?
Because it is a moving target, comprised of moving parts. And it is the result of the Fed’s own previous actions.
There is only one cause of inflation: government. The term government also includes central banks, especially the US Federal Reserve Bank.
What most people refer to as ‘inflation’ or its causes are neither. They are the effects of inflation. The “increase in the general level of prices for goods and services” is the result of the inflation that was already created. …Kelsey Williams
Bernanke pushed until he got his way. A formal, precise inflation target rate of 2% was adopted at the FOMC meeting on January 24, 2012.
Five years later…
HEADLINE: The Fed’s Janet Yellen could use some target practice
Quote: Ever since the Federal Reserve adopted an explicit inflation target of 2% in 2012, the central bank has had limited success in hitting it. Only once, in fact, in the months between April 2012 and today, did the year-over-year increase in the personal consumption expenditures (PCE) price index breach 2%. …MarketWatch/Caroline Baum 12July2017
That shouldn’t be a surprise given that it’s a moving target. But there is more to it than that.
Right now, the inability to hit the target serves as the Fed’s perfect excuse for not acting more decisively. This is especially true with respect to raising interest rates. In addition, Ms. Yellen is afraid to do anything. Here’s why.
The bigger risk to the economy and financial stability is another credit collapse. And they can’t claim ignorance as they did the last time. They know its coming. They just don’t know when.
The levels of debt, the convoluted intricacies of the derivatives market, the interwoven relationships within the shadow banking system are all at hugely more precarious tipping points than ten years ago.
And it is the Fed’s own inability to hit the 2% inflation target that is warning them.
Think of all the hundreds of billions of dollars that went into saving the system from collapse before. And then force feeding the money drug into the patient for another nine years.
The problem is that all of the beneficiaries (i.e patients) of the Fed’s assistance are now hard-core addicts. If the Fed tries to raise rates they could very easily trigger another collapse much worse than before.
The Fed continues to look for the effects of all of those hundreds of billions of dollars to show up in the ‘rate’ of inflation. Supposedly that would be a sign to them of improved economic activity and growth. That isn’t happening.
The reason is because most of the ‘help’ effects showed up in ever higher prices for financial assets (stocks and bonds) and real estate.
And all of those toxic assets (CDOs of every letter and color, and various other esoteric derivatives) have swollen in price to levels far beyond any reasonable value. In addition, far too many of them are resting quietly on the Fed’s balance sheet.
The Fed has actually blown another bubble much bigger than the previous one. Nothing fundamental has changed. The only difference is that the situation is worse than before. Now, out of fear, they are trying to steer a course between action and inaction.
The action, of course, is raising interest rates and offloading their own balance sheet. But their actions could trigger events similar to 2007-08. In which case the Fed’s image would forever be tainted. (I think this is more of a concern for Janet Yellen than her fellow board members.)
The inaction – doing nothing – is pretty much where things are currently. If the Fed maintains ZIRP (zero interest rate policy), the patient could overdose and slip into a coma.
The Fed’s 2% inflation target is an attempt to predict the effects of inflation. That’s impossible. It is also unwise as it reinforces the acceptance of a “little inflation” as normal, necessary. It isn’t.
A “little inflation” is why the U.S. dollar is worth ninety-eight percent less than in 1913 when the Federal Reserve originated.
By Kelsey Williams