Monday, January 24, 2011

Inflation Targeting, Best Option for the Fed?

Joseph Stiglitz (Economics Nobel Laureate) July 2009 on risks of relying solely on inflation targeting (1 min long)

Inflation made above the fold, front pages news today on the Wall Street Journal. Many countries around the world (Brazil, India, China and the Euro zone) are now facing inflation above 2% - the ideal level according to economic consensus. Increases in the prices of food, oil, and other raw materials are the prime sources of the current epidemic of inflation. The U.S. is recovering more slowly from the recession, and is still facing inflation below 2%.

From an economic policy perspective, today's article in WSJ outlook is more interesting. It discusses how the chairman of the Fed, Ben Bernanke, has long been a fan of inflation targeting. Many countries have already adopted an explicit inflation target of 2%. The key advantage of inflation targeting is that it simplifies the message for central banks, and makes their actions more predictable. Stiglitz (in the very short video above) highlights the dangers of relying solely on inflation targeting and ignoring the financial sector. Clearly things can still go wrong even if inflation is low and stable. If  the price increases of financial assets (like stocks and housing) were incorporated into a broader measure of inflation, perhaps this criticism could be overcome.

WSJ (1-24-2011) New Push at Fed to Set an Official Inflation Goal

WSJ (1-24-2011) Global Price Fears Mount

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