Friday, May 18, 2012

Flexible Inflation Targeting Is Just Fine

The Atlanta Fed's David Altig is the latest central banker to defend flexible inflation targeting (FIT).  He says it "feels about right" to him.  This follows the Bank of Canada's Mark Carney who claimed earlier this month that FIT  "proved [its] worth through crisis and will be essential to sustain the recovery." Really? I did not realize that the FOMC deciding not to cut the target federal funds rate in September, 2008 because of inflation concerns makes one "feel right" about FIT. The economy was in free fall, but hey the Fed kept inflation expectations anchored! I also did not know that the ECB increasing interest rates in 2011 because of inflation concerns "proved its worth" during the crisis. Nothing like reigning in inflation expectation during the Eurozone Apocalypse. I also did not know that keeping inflation low over the past few years was "essential to sustain the recovery" in Europe and the United States.  Silly me, I thought that those the large-scale asset purchases (LSAPs) and long-term refinancing operations (LTROs) were an important part of the monetary policy stimulus too.  I guess I was wrong.  All along is was really  just FIT! Yep, there is no need to worry about the level of aggregate nominal spending being below trend and the insufficient aggregate demand problem. It  all can be fixed with FIT. 

P.S. Jeffrey Frankel nails it with this FIT RIP article.  The fact that FIT advocates cannot see that FIT was grossly inadequate for this crisis--if it works so well then why resort to LSAPs and LTROs?--and thus, not a general approach to monetary policy is telling. Why not take a more direct approach that directly targets aggregate demand rather than an imperfect symptom of it? 

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