William Poole and Milton Friedman on Inflation Targeting and the Post-Greenspan Fed

Interesting comments by St. Louis Federal Reserve Bank President William Poole on his support of inflation targeting, the transition to a new Fed chair and how that might affect the Fed’s credibility, his discomfort with language such as “measured,” and other matters.  Comments by Milton Friedman in support of inflation targeting are also noteworthy given his long-standing advocacy of quantity targets:

Post-Greenspan Fed will face credibility test-Poole, By Alister Bull, Reuters:  Federal Reserve Chairman Alan Greenspan's eventual successor faces a stiff credibility test from markets but could ease the transition by adopting a target for inflation, top U.S. economists said on Wednesday. St. Louis Federal Reserve Bank President William Poole said markets currently expect a period of low U.S. inflation to continue well after Greenspan departs office early next year, but warned that confidence would likely weaken somewhat. … "The Fed's inflation-fighting credibility may be somewhat more fragile over the next few years than it has been over the past few years." … Nobel-prize winning economist Milton Friedman, who joined Poole and other monetary experts to discuss how the Fed would fare after Greenspan, said the case for adopting inflation targets was clear.  "Greenspan didn't need these rules...(but) what we need for the future is for the government to set inflation targets and to hold the officials responsible for them," he said. ... Friedman warned that without a target, the attraction of inflation may be hard to resist. … Greenspan has resisted adopting a formal target for inflation, which is the practice in Britain, the euro zone and a number of other industrialized countries, warning that this would limit Fed flexibility.  Poole, a long-standing advocate of targeting, made plain that he did not see the merit in reflating the economy at the expense of the target in response to a severe economic shock.  "I'd be pretty adamant myself of sticking to the inflation target," he said in answer to a question. … Poole said the Fed had made large strides toward policymaking transparency under Greenspan, contributing greatly to the central bank's success and the economy's health.  However, Poole's remarks showed he remains uncomfortable with the Fed's recently adopted practice of providing forward guidance on the monetary policy path it expects to take.  He said the "measured pace" language introduced by the Greenspan Fed to characterize its current monetary tightening cycle was an example of this untested "significant departure" that may eventually need to be reassessed.  "I have been concerned ... that the Federal Reserve not make promises about the future setting of the federal funds rate that...it might not want to honor," Poole said. "I think it's a tricky business," he said. "If we can get across that these forward statements are our best guess, conditional on the information we have at the time we make them ...then I think that the forward statements may be constructive," he added.

I agree, particularly with the last statement. There is a danger of staying on a particular path too long simply because the market expects the Fed to continue along it based upon such language, and deviating from the predetermined course of action would upset markets.  I believe the message that statements such as "measured" are data dependent is beginning to resonate in financial markets and more generally as well.  If so, then signaling future intentions is a helpful development.

Update:  Here is a copy of Poole's remarks. Thanks to SCSU Scholars for the link.  William Polley says, "The speech isn't that long. As they say, read the whole thing."  Also, this editorial in the CSM "When warnings become a scare" talks about how to optimally issue warnings for events like potential earthquakes and flu outbreaks and states "How should they warn about something that might never occur? Does talking about an uncertainty help - or simply raise unnecessary fears?"  Interestingly, transparency is highlighted as essential to good policy.

Comments

[anne]

Dear, I hope Greenspan stays for a while longer. Please stay. I can not imagine Poole as Fed Chair. We do not need rigidity. The only alternative would be Bernanke.

[anne]

We do not need a European central bank type, nor am I interested in Friedman's anti-inflation machine.

[anne]

I surely has no complaint about Greenspan and monetary policy, and I do hope we do not have a hawkish central banker in turn to act like Greenspan never had to act.

[Roland Buck]

"Poole, a long-standing advocate of targeting, made plain that he did not see the merit in reflating the economy at the expense of the target in response to a severe economic shock."

Maybe that's because if there is a severe economnic shock he and his peers will not become unemployed, and even if they did, they would have adequate financial resources to tide them over until the shock was over. They have no idea what things are like for a worker to lose his job and face the danger of having his house foreclosed on because they could not continue to make the mortgage payments. I grew up in a blue collar household and actually observed this situation at first hand.

Of course the New Classical myth that unemployed workers are just choosing leiusure helps blind them to this reality.

We only have to look at the German economy to see the havoc that rigid inflation targeting can work on an economy.

Long-run inflation targeting, with deviations made in the short run to offset recessions, which appears to be what Greenspan has done, is, on the other hand, a policy for which a good case can be made.

[Björn Lundahl]

Why not look at Canada? The Bank of Canada has pursued a monetary policy of inflation targeting for many years and it has been a success story. Alan Greenspan followed implicitly that policy as well. Inflation targeting allows for flexibility as long as the inflation target is met. The ECB acted more aggressively and pumped a lot more liquidity into the financial systems during the credit crunch than the Federal Reserve.

Björn Lundahl
Gothenburg, Sweden

[anne]

Inflation targets may be impossible for the Federal Reserve which has a dual mandate of checking inflation and promoting employment. I have long thought monetary policy for the Euro countires too limiting.

[Björn Lundahl]

“Long-run inflation targeting, with deviations made in the short run to offset recessions, which appears to be what Greenspan has done, is, on the other hand, a policy for which a good case can be made.”

That is also what all inflation targeting central banks have done as well. It is called flexible inflation targeting and all central banks that pursue an inflation targeting monetary policy are in the short run very flexible and respond very quickly to combat economic shocks.

An inflation targeting central bank has greater options to be more flexible than a non targeting central bank as inflationary expectations are usually more anchored among the public and will still be so if, for example, the central bank temporarily lowers the rate of interest to offset an economic shock. This fact makes the “stimuli” more effective as it will not, because of unchanged inflationary expectations, increase inflation.

Go to:

Remarks by Governor Ben S. Bernanke
At the Annual Washington Policy Conference of the National Association of Business Economists, Washington, D.C.
March 25, 2003

A Perspective on Inflation Targeting

http://www.federalreserve.gov/Boarddocs/Speeches/2003/20030325/default.htm

Remarks by Governor Ben S. Bernanke
At the meetings of the Eastern Economic Association, Washington, DC
February 20, 2004

The Great Moderation

http://www.federalreserve.gov/Boarddocs/Speeches/2004/20040220/default.htm

Video:

Ben Bernanke at Princeton

http://www.youtube.com/watch?v=Pzi7DhKbHOU