Comments on Aplia Econ Blog: News for Economics Students: Why Does Bernanke's Small Talk Move Markets?

Here's an article related to Bernanke and financia...

2006-06-06T15:17:00.000-07:00

Here's an article related to Bernanke and financial markets.

http://biz.yahoo.com/ap/060606/wall_street_close.html?.v=3

"Bernanke came in with this reputation as a great communicator," said John Caldwell, chief investment strategist for McDonald Financial Group, part of Cleveland-based KeyCorp. "Most of us would choose to go back to the general confusion (former Fed Chairman Alan) Greenspan created."

For more on the inflation targeting debate...
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2006-06-06T08:33:00.000-07:00

For more on the inflation targeting debate...

In favor

Paul Romer pointed his econ students to a working paper from the San Francisco Fed:
http://www.frbsf.org/publications/economics/papers/2006/wp06-09bk.pdf
Read the abstract and introduction. The authors find some evidence that explicit inflation targets anchor long-term inflation expectations.

Against

Wolfgang Munchau of the FT makes claims similar to William's but provides some evidence from Sweden to back them up:
http://news.ft.com/cms/s/0e22c72e-f3e6-11da-9dab-0000779e2340.html
(Subscription required)

Notice that quite a bit of the debate centers on what people mean by an explicit inflation target. Is it a policy mandate to keep inflation within a certain band? Is it simply a public announcement of the Fed's concensus on a range of inflation rates that constitute price stability? Opponents of more public targets tend to characterize targeting as a strict rule. Advocates seem to characterize targets as publicly stated goals that central banks are free to deviate from for as many as several years at a time.

The debate continues...

The goal of the Federal Reserve is two fold -- to ...

2006-06-05T14:42:00.000-07:00

The goal of the Federal Reserve is two fold -- to maintain price stability and low unemployment. Often times there is a conflict between these two goals, and it is up to the Fed to decide which goal is more important.

Announcing an explicit inflation target is problematic in two ways:

1. Explicit inflation targets MAGNIFY financial market fluctuations.

The Fed has no a priori control over the inflation rate. The Fed's control of the federal funds rate has an effect on the inflation rate only if it sufficiently influences long-term rates. The problem lies in the fact that there is often a long lag between changes in short- and long-term rates. If the Fed announces a "5% medium term inflation rate" but misses that target, then financial markets will expect even higher rates in the next term and send shares plumetting (even though the Fed might NOT have to raise rates to achieve lower FUTURE inflation due to time lags). Investing in the stock market will be more risky with an explicit inflation target.

Aside from monetary policy lags that might steer the Fed away from its explicit inflation target, exogenous shocks also further weaken the Fed's ability to meet its inflation target.

2. Explicit inflation target WEAKENS the Fed's inflation-fighting crediblity.

I mentioned two practical humps that prevent the Fed from acheiving its explicit inflation target: lags and shocks. But when the market sees that there are often gaps between the actual inflation rate and the target inflation rate, they will begin to doubt whether or not the Fed is actually an inflation fighter. It doesn't take much for the market to lose faith.

And if the Fed changes the explicit inflation target, that will further cause additional rounds of Fed speculation.

The alternative to explicit inflation targeting is IMPLICIT inflation targeting. Do what Greenspan did. Make policy is a secret room, and announce it with some justification to the rest of the world. More information isn't necessarily better for the economy.

Comments on Aplia Econ Blog: News for Economics Students: Why Does Bernanke's Small Talk Move Markets?

Here's an article related to Bernanke and financia...

For more on the inflation targeting debate...<...

The goal of the Federal Reserve is two fold -- to ...

For more on the inflation targeting debate...
<...