Inflation Targeting or Deflation Avoidance?

Commentary by Bob McTeer

Source: Forbes

Back in the day when I served on the FOMC (February 1991-November 2004) under Alan Greenspan, the subject of inflation targeting came up from time to time. I never liked the idea, but a few of my colleagues expressed an interest. Fortunately, from my point of view, Chairman Greenspan didn’t like it and never scheduled a formal debate, not even after Ben Bernanke joined the Committee the first time. Ben made no secret of his support for an inflation target, but he never pushed hard for it back then. It was only after he returned to the Committee as Chairman later did he rally support and pushed it through.

My opposition to inflation targeting was not very sophisticated. I simply though of inflation as bad and didn’t want to officially condone it. Now we have inflation targeting, and it has become a prominent part of discussions of monetary policy as one of the FOMC’s dual objectives. Frankly, I’ve been surprised at the apparent general acceptance of the goal of two percent inflation by the talking heads on financial TV. I’m not surprised at its support from the academic community. I would have thought that the talking heads would take a less sophisticated position, as I did.

This is guesswork on my part, but I really doubt that members of the FOMC really want two percent inflation. Extrapolating from my own thinking on the subject, I’ll bet they would prefer one percent inflation, or even lower, if there were little danger of the lower inflation morphing into deflation. What I really want, and I’ll bet many of them agree with me, is not two percent inflation, but no deflation.

None of them will fess up, but I’m guessing that, given the improved performance of the labor markets, and, the shift of attention almost exclusively to the inflation goal, the FOMC will begin a gradual, slow process of interest-rate normalization even while headline inflation rates remain very low or go even lower, as long as the core rates hold up. In other words, if headline inflation is depressed primarily because of oil prices, that will not deter the FOMC from beginning the normalization process earlier rather than later.