This commentary was written by Dr. Daniel Thornton of D.L. Thornton Economics. Thornton spent over three decades at the St. Louis Fed as vice president and economic advisor.
More than 30 central banks have adopted inflation targets. The Reserve Bank of New Zealand was the first, in 1990; the Fed was one of the last.
It adopted a 2% inflation target in 2012. Inflation targeting was motivated by a variety of factors, not the least of which is the fact that the Fed was credited with ending the Great Inflation in the early 1980s.
The recent high inflation rate calls into question the efficacy of inflation targeting. In an analysis of the effectiveness of monetary policy generally and inflation targeting in particular by two former colleagues, Robert Rasche and Marcela Williams (here), evaluated the effectiveness of inflation targeting. They found the results to be mixed. Inflation targeting seemed to work for some countries but not others.
They suggested that inflation targeting may not be a panacea, saying “it is not clear what will happen to low and stable inflation if “bad shocks” are realized and the going gets tough.”
There is yet another reason to question the effectiveness of inflation targeting. Economists call the period from about 1984 to 2007 the Great Moderation. This period was characterized by increasing output that was relatively stable.
It only was interrupted by two relatively short and mild recessions. James Stock and Mark Watson did a careful analysis of the Great Moderation using data through 2002 (here). Based on their analysis, they concluded that “improved monetary policy can take credit for only a small fraction of the great moderation.”
The recent acceleration of inflation is consistent with these analyses. It strongly suggests that the apparent success of inflation targeting the U.S. and elsewhere may be due to good luck rather than central banks adopting inflation targets, as many economists have asserted.
Post script: Rasche and Williams concluded their analysis with the statement: “the case for consistently effective short-run monetary stabilization policies is problematic—there are just too many dimensions to uncertainty in the environment in which central banks operate.”
I agree completely. I would add there is no evidence that the Fed’s monetary policy actions since 2008 have reduced long-term rates, improved the functioning of financial markets, or anything else. For those who claim that they have been effective, I say “show us the evidence!”
Please don’t claim they have been effective by saying “things would have been much worse if the Fed hadn’t manipulated its federal funds rate target and purchased $8 trillion of long-term Treasuries, mortgage-backed securities and agency debt.”
This is a statement of faith, not science! A science lives or dies by facts, not faith.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor piece written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.
