Tuesday, July 10, 2007

Laying the Groundwork for Inflation Targeting?

In a speech today to an NBER conference, Ben Bernanke expressed concerned that inflation expectations are not sufficiently "anchored." From the Washington Post story by Nell Henderson:
Fed officials believe it is critical to hold down inflation expectations because of the danger that they can be self-fulfilling: if consumers expect prices to rise, they may more readily pay higher prices; if businesses expect inflation to pick up, they may be quicker to raise their own prices to cover their costs.
"Undoubtedly, the state of inflation expectations greatly influences actual inflation," Bernanke said.
Ideally, if inflation expectations are very stable, or "anchored," they won't vary with swinging oil prices, economic booms or busts, employment data or other changing aspects of a dynamic economy. Bernanke said expectations are better anchored than in the past, but not completely -- they still respond to economic news.
The chairman was careful not to make any specific suggestions, but certainly one way to "anchor" expectations would be to adopt inflation targeting. Under inflation targeting, the central bank announces a specific target level or range for inflation, and conducts monetary policy with the goal of meeting its stated target. Britain, Canada and New Zealand all use inflation targeting, and it has generally been regarded as a success. However, it might constrain the Fed's flexibility under unexpected circumstances (Greenspan's objection), and it it would seem to contradict the Fed's "dual mandate" to achieve price stability and low unemployment by giving primacy to price stability (the likely objection of Congressional Democrats).
As an academic Bernanke was an advocate of inflation targeting and his speech today might be a gentle attempt at nudging people in that direction.


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