ECON430-Topic #1: The Fed, Transparency, Inflation Targeting, and the Dual Mandate

Recently the Fed has been discussing changes to their inflation target as part of their dual mandate. If Fed officials hope to adopt a strict inflation target in the next year or two, they will also need to consider how the transparency of their actions are viewed by the larger economy. They have been moving towards greater transparency in the past few years, as they have expanded their communications strategies to include more information on their forecasts and regularly scheduled press conferences. Additionally, the Fed still must consider employment levels, since that is still technically part of their mandate.

Other central banks like the U.K. and the ECB have even greater transparency about their policy actions, but also have more restrictions regarding their activities. For example, the U.K. central bank has to explain their policy actions when they miss their inflation targets. In New Zealand, the central banker can lose their job if they do not get inflation into their target zone. The Fed isn’t considering adopting any of these measures, but they are facing some small operational changes.

Questions you might answer (Do not answer all points, just focus on one)

  • Should the Fed be considering a move towards stricter inflation targets? Why or why not? Would it be better to maintain the flexibility they have had in the past going forward?
  • What problems might arise if the Fed adopted a strict inflation targeting stance? Have other central banks who have taken these steps faced these types of problems? What flexibility is the Fed considering putting into their new policy?
  • Does inflation targeting imply that the Fed would have done anything differently in the 2007-2008 crisis? If so, what might they have done differently? What might the policy stance today be if the Fed were strictly targeting inflation?

11 thoughts on “ECON430-Topic #1: The Fed, Transparency, Inflation Targeting, and the Dual Mandate”

  1. I think that the Fed has been doing an excellent job throughout the entirety of the financial crisis and that it should not move towards stricter inflation targets. In the BusinessWeek article Gage notes that “investors anticipate that the Fed will achieve its longer run goal of 1.7 percent to 2 percent,” and with the economy growing at 2.3 percent it is clear that Bernanke and the Fed have been doing a good job in making sure our economy isn’t heading towards another recession (1). Stricter inflation targets means that the Fed would be intervening much more with the economy and even as the economy continues to grow it is not completely stable and Bank of England Governor Mervyn King said that during times of volatility actions by the central bank to more strictly target interest rates “risks generating undesirable volatility in output (1).” I also believe that greater transparency would allow markets to better anticipate moves made by the Fed which would reduce volatility resulting from those decisions. And while they will have to publish more records indicating what they are trying to do, I don’t believe they should lose any of the flexibility they have had in the past to quell financial turmoil. I believe that as the economy is becoming healthier and healthier we should not be trying to limit the powers of the organization that is responsible for the economy’s recovery. Limiting the central banks’ ability to be a lender of last resort and provide needed liquidity during a financial crisis would be making the Fed’s already difficult job much more difficult (2). We need a central bank that has the ability to react quickly and decisively during a financial crisis.
    (1) http://www.businessweek.com/news/2012-01-23/fed-dual-mandate-shows-bernanke-s-model-working-better-in-crisis.html
    (2) http://www.americanbanker.com/bankthink/bailout-emergency-funds-federal-reserve-dodd-frank-1042138-1.html

  2. The Fed is responsible to ensure lower future inflation rates and to lower current unemployment rates. It’s a tough gig. Lower inflation rates will promote firms’ investment in capital stock and subsequently increase future GDP. But by lowering inflation and increasing capital stock investments, consumption today simultaneously drops because the savings rate and consumption are inversely related. Lower consumption today makes it difficult for the Fed to address the second part of its mandate- to lower current unemployment rates. The fed is capable of putting their efforts to addressing inflation and unemployment both by a little bit, and they have been. But there’s a distinct possibility that focusing on current unemployment is more beneficial than targeting inflation rates for the short-term and the long-term. By making their moves transparent and announcing they will push to correct current unemployment, the Fed may give firms hope from increased consumption today. Firms will be profitable and be able to invest in future capital stock. Stephen Gandel, of Time Business (http://business.time.com/2010/04/05/whats-worse-high-unemployment-or-inflation/) writes higher employment today would promote better skilled workers and in the long run result in higher output. Targeting inflation may have a positive effect on long-term growth, but it won’t necessarily lower current unemployment. Lowering current unemployment, however, may result in positive long-term growth.

  3. I think that the Fed proposed commitment to low interest-rates through 2014 gives credence to the Fed’s attempts to establish an inflation target while becoming more transparent. According to Mullaney, the Fed still predicts a weakened economy, and inflation is staying below 2%. By prolonging the period of low interest rates, inflation should remain below 2% (1). This bodes well for borrowers. By communicating a long term inflation goal, expectations are kept firmly anchored, fostering price stability (2). However, savers are hurt by the low interest rates. Because of the fear of low interest rates, more consumers are buying gold and silver. According to the London gold Market Report, gold prices within the last week have risen by 3.8% (3).

    1. http://www.usatoday.com/money/economy/fed/rates/story/2012-01-23/federal-reserve-forecasts/52786100/1
    2. http://www.reuters.com/article/2012/01/25/us-usa-fed-inflation-target-idUSTRE80O25C20120125
    3. http://goldnews.bullionvault.com/gold_fed_012620127

  4. I think it would follow their trend and direction of recent policy shifts if the fed both set stricter inflation targets AND disclosed those targets, their logic, and plans of how to reach those targets. Inflation target transparency translates to banks and other investing firms being able to better predict the interest rate to be set by the fed and therefor stabilizes investment. Stability and trust are two of the most premium qualities of a thriving economy; our deepest recessions have been largely attributable to public economic confusion and instability which leads to less investment as people consider their money safest under their mattresses. The key to stricter inflation policy being effective, therefor, is public confidence in that information. Ben Bernanke discusses in his article “A Perspective On Inflation Targeting” (http://www.federalreserve.gov/Boarddocs/Speeches/2003/20030325/default.htm) that the difference between scientific models and economic models is that despite the best economic forecasts, public interpretation of information is difficult to predict. Flexibility towards inflation can be a positive tool in coping with financial crises or undesirable economic conditions; but if the fed demonstrated they can set an inflation target and provide completely reliable information I feel we would be able to avoid or ameliorate future crises.

  5. With unemployment rates increasing and inflation rates also on the rise, the economy would benefit from the Fed adopting a stricter inflation targeting policy. According to the Bloomberg article, in August 2011 the unemployment rate had risen to 9.1% and the price-consumption-expenditure (PCE) price index increased 2.9% (1). With both inflation and unemployment increasing and taking into account the “inflation-unemployment trade off,” the Fed needs to make a decision on which problem it should tackle first. Supported with evidence from a paper published by the IMF, the best route would be for the Fed to adopt a target inflation rate. Even though targeting inflation would reduce flexibility in stimulating the growth of the economy by limiting actions such as quantitative easing, the adoption of inflation targeting would improve the inflation-unemployment trade off (2). In other words, targeting the inflation problem would be associated with an unemployment rate that increased at a slower rate. Therefore, the Fed could tackle the inflation issue, and also slow the growth of the unemployment rate. The flexibility of stimulating growth seems like a reasonable sacrifice for a stable inflation rate paired with a slower growing unemployment rate.

    (1) http://www.businessweek.com/news/2012-01-25/fed-dual-mandate-shows-bernanke-s-model-working-better-in-crisis.html
    (2) http://www.imf.org/external/pubs/cat/longres.cfm?sk=15416.0

  6. As the Federal Reserve becomes an increasingly transparent entity, information becomes readily available to the public. Corporations and market expectations will initially be priced into the market. Inflation expectations are previously determined therefore fears of inflation might be removed from the market entirely.
    Since he assumed his position in 2006, transparency within the Federal Reserve was Bernanke’s primary goal. Increasingly available public information pertaining to the daily activities of the Federal Reserve, will remove fear or unexpected actions from the market.
    The Federal Reserve, on Wednesday, set long-run inflation target of 2%. (1) This goal is seen as a progression toward an actual inflation target. This long-run inflation target of 2% could calm market fears of inflation and could perhaps help identify real long-run interests.
    Once year-ending economic data for 2011 becomes available; the question remains whether the Federal Reserve will seek more quantitative easing (a new round of bond buying)(2) as some have predicted for the coming year.
    With a long-run inflation goal of 2%, would this next round quantitative easing have any effect at all? Particularly because inflation target expectations are previously calculated into interest rates, some would think this would have no effect on rates or output.

    1. http://www.reuters.com/article/2012/01/25/us-usa-fed-inflation-target-idUSTRE80O25C20120125
    2. http://www.reuters.com/article/2012/01/25/us-usa-fed-idUSTRE80O27M20120125

  7. As far as the Fed targeting inflation rates is concerned, I am happy for its attempt at increasing transparency and trying “keep longer-term inflation expectations firmly anchored” (1). Its also hard to deny rising inflation rates, as we as consumers have seen rising prices over the last few years since the financial crisis, and the actual numbers don’t deny it either (2). I think this is a particularly interesting time for Bernanke and the rest of the fed, as they now seem to be out of crisis mode and looking to hopefully a brighter future, but they are also shadowed by looming high rates of unemployment, a growing labor force, massive national debt, and all this in an election year. I think it is also hard to deny that the US dollar will probably have to suffer more inflation that we might like in order to handle the national debt. And as we all know, the only way to handle the national debt would be to raise taxes, cut government spending (in an election year? what are the odds of that happening) or… monetization.[or we could just hope that Warren Buffet will pick our tab (3).] I think given the circumstances it hard to deny more inflation is around the corner, hopefully Bernanke and the fed are able to navigate the further financial uncertainties of the near and coming future. Do I think the that Fed should move toward stricter inflation rates? I don’t know, but I think given all of the changes that have stricken the economy in the last decade, I would have to support the Fed with flexibility in its discretion before we can attempt to stabilize growth with a central bank using policy closer to monetary rule.

    (1)http://blogs.telegraph.co.uk/finance/andrewlilico/100014373/the-feds-inflation-target-is-not-what-it-seems/
    (2)http://inflationdata.com/inflation/inflation_rate/historicalinflation.aspx
    (3)http://www.rawstory.com/rs/2012/01/11/buffett-offers-to-match-republican-deficit-donations/

  8. I think as a long term goal, establishing more strict inflation targets would be a good idea, and would help to remove some of the ambiguity of the actions that the Fed currently makes. At the time being though, their main focus should be to help with fighting the rising unemployment that we currently face, and their projection of keeping rates low until 2014 is right on point with that (1). At the time being, keeping the low rates have also been the answer for stable inflation, and right now this should be the way they continue to act. By keeping borrowing rates low, it is further stimulus in order to try and increase Investment and combat unemployment. Any attempt to raise rates to hit a certain inflation target wouldn’t be a good idea, as it would possible sacrifice employment, which is a bigger issue in my eyes, and should be a bit more in the fore-front of any monetary policy at the moment. Even with the low rates, the Fed has not been too far off of their 2% targets for inflation (2) with the inflation rate sitting around 3% for the past 6 months(3), and have been able to keep this rate consistent, as we have seen much lower variation in the inflation rate since March of 2011. In the future, focusing on a more strict inflation should be a main goal of the Fed, but I agree their decision to stand by low rates until 2014 and focus on attempting to bring this country out of the recession rather than meeting some numbers.
    1) http://www.bloomberg.com/news/2012-01-25/fed-says-benchmark-interest-rate-will-remain-low-until-at-least-late-2014.html
    2.) http://blogs.marketwatch.com/thetell/2012/01/26/inflation-expectations-rise-since-fed-comments/
    3.) http://www.usinflationcalculator.com/inflation/historical-inflation-rates/

  9. I don’t think we should adopt a strict inflationary target. However, I can see how people would “throw around” the idea. It could and has been proven to decrease volatility in markets and help investors make better decisions. This leads to more stability in the economy which is, in many cases, connected to a thriving economy. But, the bad outweighs to the good in inflationary targets. It ties the hands of the government. If there was an unexpected shock in the economy while participating in inflationary target policy the government could not carry out some policies that’s would help stabilize the shock, this could lead to a large drop in our country’s output. Another problem is picking the rate of inflation. If the country picks a rate to low, then it could have serious repercussions on the labor market and the flexibility of real wages. I am also a firm believer in the saying “if it isn’t broken, don’t fix it”, which was brought up in the journal I read. With inflationary target the country is really just “fixing” something that isn’t broken at all. If the country were to put a inflation target in place, I would insist government to include certain escape clauses where they could change the target in the case of an economic shock.
    Source: http://web.pdx.edu/~ito/Bernanke_Mishkin1997JEP.pdf

  10. Moving toward stricter inflation targets can help the economy in a number of ways. First, if the Fed had been successful in the past at meeting targets, establishing any new targets would provide stability to the market and alleviate uncertainty about what the Fed is planning to do. Second, should the Fed decide to target a range of inflation values, the narrower the range the more credible the Fed appears (1).In other words if the Fed selected a wide range of where they expected the inflation rate to be, this uncertainty would undermine their credibility because it appears that they are unsure about where the economy is heading. An article by the IMF suggests that of seven industrialized countries studied whose central bank targets inflation, 6 of them have been successful in achieving their target rate albeit all of them did experience increases in unemployment (1). At first glance it appears that requiring a central bank to target a variable such as inflation would make the bank inflexible to respond to other potential changes in the economy. However, Mishken writes that despite recent shocks and the subsequent actions taken by the Fed, the long run inflation expectations have remained relatively stable (2).

    (1) http://www.imf.org/external/pubs/ft/issues/issues15/index.htm
    (2) http://www.federalreserve.gov/newsevents/speech/mishkin20080111a.htm

  11. Despite the fears of politicians that the Fed’s efforts to target inflation will be at the expense of unemployment, I believe the move to reach 2 % inflation will be beneficial, with some caveats. Lilico notes that traditionally, inflation targeting involves definite amounts of time. Additionally, inflation targets from other countries are generally presented as a target range or a maximum percent that will be permitted each year (ie: in 2012 inflation will be no more than 3%). The Fed’s policy does neither of these things. Ben Bernanke has touted increased transparency of the Fed as a goal since his confirmation hearing in 2009. In order to accomplish that goal, the policies themselves must be clear. Price stability via inflation targeting cannot be accomplished without the Fed being more explicit in the details of its targeting strategy. Additionally, leaving out specifics may have been a calculated maneuver by the Fed, as inflation targeting is not without its perils. Gage notes that Norway and Sweden’s interest rate projections had to be changed last year and that can introduce a sense of “false certainty” and volatility. I believe that the Fed was giving itself some flexibility should the recovery begin to falter and/or should the Fed need to focus more on unemployment, if it were to become a larger issue. Although it is not a fully explicit inflation target, the news was a step in the right direction by the Fed, and the flexibility and lack of a time table will allow Bernanke to appease those who focus on unemployment.

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