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Fed's Mishkin Reiterates Support for Inflation Target in Book

By Scott Lanman

Oct. 10 [2007] (Bloomberg) -- Federal Reserve Governor Frederic Mishkin, in a new book, endorsed linking interest-rate policy with a specific target for the inflation rate.

Having a numerical goal for price increases, with a ``tolerance range'' around it, is as an ``excellent'' way to conduct monetary policy, Mishkin wrote in ``Monetary Policy Strategy.'' The book, scheduled for release in November by the MIT Press and a copy of which was sent to Bloomberg News by the publisher, was completed before Mishkin's Fed appointment.

The comments outline Mishkin's views just before he joined the central bank last year and started participating in the Fed's review of how it communicates policy. Mishkin wrote that a target would commit officials to make the ``tough decisions'' needed to contain inflation and would help limit political interference.

Inflation objectives between 1 percent and 3 percent have similar outcomes for the economy, research shows, according to Mishkin's book. The Fed governor's support for price goals dates to the mid-1990s, when he began collaborating on research with Ben S. Bernanke, who became Fed chairman in February 2006.

While former Chairman Alan Greenspan's strategy of having an ``implicit'' inflation goal was ``enormously successful,'' future Fed chiefs aren't guaranteed to be ``strongly committed to inflation control,'' Mishkin said in the book, mostly a compendium of past papers with some fresh material including the final chapter.

1970s Inflation

``In the past, after a successful period of low inflation, the Federal Reserve has reverted to inflationary monetary policy -- the 1970s are one example -- and without an explicit nominal anchor like an inflation target, this could happen again,'' wrote Mishkin, 56, who is on leave from Columbia University and was the New York Fed's research director from 1994 to 1997.

Bernanke provided ``helpful comments'' on the chapter, Mishkin said in a footnote.

The Fed's current mandate, set by law, is to pursue stable prices, high employment and low long-term interest rates. Some Fed officials, including district bank presidents William Poole of St. Louis and Charles Plosser of Philadelphia, have argued that containing inflation is the best way of achieving all the objectives.

``Price stability should be the overriding, long-run goal of monetary policy,'' Mishkin wrote in the book. He opposed setting a target for employment, saying it would make inflation ``subject to higher levels and volatility'' as well as cause swings in gross domestic product.

By contrast, Representative Barney Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, has faulted the Fed for having an excessive focus on inflation.

Fed and Politics

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Rate Forecasts

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Mishkin noted that an inflation goal could be set to the level of prices, or the rate of increase in prices. One disadvantage of an inflation-rate objective is that any failure to meet the target is never made up for later. At the same time, targeting specific price levels could roil economic output.

Some arguments indicate that a ``highly desirable'' alternative would be an inflation-rate target defined as an average over several years, Mishkin wrote. That way, the central bank would need to offset some of the overshoot or undershoot of the target, he said.

Several officials, including Bernanke before he became chairman, have said their ``comfort'' zone for the Fed's preferred inflation gauge is 1 percent to 2 percent. The year-on- year measure, which is tied to consumer spending and excludes food and energy, was 1.8 percent in August. [Oyeah.] Mishkin didn't specify what index should be used to set an inflation target.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net .

Last Updated: October 10, 2007 14:27 EDT

http://au.blogs.yahoo.com/futureinvest/39/bernanke-correct-to-target-inflation

This was dated Feb 02 - presumably that was 2007.

The Mandated Goals of the Fed

The current Congressional mandate to the Federal Reserve goes back nearly three decades.� In response to soaring inflation of the 1970s, the U.S. Congress passed the Full Employment and Balanced Growth Act in 1978, which required the Fed to pursue policies that promote ?full employment, low long-term interest rates, and reasonable price stability.?� Since low long-term interest rates would not be possible without low inflation, this Act was interpreted as requiring the Fed to pursue the dual mandate of full employment and low inflation.

Because of a growing body of theoretical and empirical studies, economists concluded that monetary stimulus can influence employment only temporarily, but has a far more permanent impact on inflation. Targeting a high level of employment may instead bring about a higher and accelerating rate of inflation.

Inflationary Expectations

The works of Nobel Laureates Milton Friedman and Edmund Phelps showed that inflation, once started, soon generates ?inflationary expectations.?� These expectations accelerate the inflationary process.� This is because inflationary expectations become incorporated into the price setting behavior of firms, labor and rental contracts, and interest rates.� Inflationary expectations can also depress the dollar on the international markets, raising the cost of all imported goods, including oil.

Once inflationary expectations take root, inflation becomes far more difficult to eradicate. To do so, the central bank must raise interest rates sharply, as they did in the early 1980s, which in turn precipitated a recession.� The end result is an unemployment rate higher than it would have been if inflation were stamped out early.

This view of how the economy works is accepted by virtually all central banks around the globe.� It was for these reasons that the world?s major central banks, such as the Bank of England, the Bank of Japan, and the European Central Bank rewrote their charters in recent years to elevate price stability as their number one goal.� They did this not because they believed that conquering inflation was more important than maintaining a strong economy, but because they knew that trying to target employment would reduce the inflation-fighting credentials of the central bank and increase inflationary expectations.

Elevating Price Stability

The Fed has not yet followed the lead of these other countries. Nearly a decade ago, Republican Jim Saxton from New Jersey introduced legislation, called the Price Stability Act, designed to put the Fed on the same footing as other central banks by elevating inflation as the primary target of Fed policymakers.

Although many at the Federal Reserve supported this legislation, Alan Greenspan, ironically, did not.� Greenspan stated that he could live with the ?dual mandate? of high employment and stable prices since in order to achieve maximum employment it was first necessary to achieve price stability. He believed that the second mandate of full employment was actually predicated on achieving the first mandate of price stability.�

This was indeed a clever interpretation of the law. Alan Greenspan?s reputation as an inflation fighter was strong enough that he didn?t need targets to back his anti-inflationary credentials.� Bond traders around the world trusted that Greenspan would keep inflation low.

But individuals of Greenspan?s stature do not always lead the Fed.� By specifying a target range for inflation, Bernanke is trying to elevate the goals of the institution above those of any individual by establishing principles that represent the best practice in central banking. In January 2000, Bernanke and Frederic Mishkin [See Bberg article above], a professor at Columbia University who was subsequently named to Board of Governors, published an op-ed column in The Wall Street Journal stating that setting an inflation target would ?depersonalize and institutionalize the Greenspan approach,? and increase the anti-inflation credentials of the Federal Reserve.

Conclusion

Bernanke?s position is correct. Maintaining anti-inflationary credentials is the most important aspect of central banking. By stating that it is the Federal Reserve?s intention to keep inflation low and within a specified range, Bernanke hopes to bring the Fed?s goals in line with those of other central banks and increase confidence in the Federal Reserve. Bernanke?s goals, if he is allowed to pursue them, will best achieve the very goals of full employment that Barney Franks and most other Americans believe is so important.