Inflation Targets: If You Can't Hit the Goal, Raising the Goalpost Won't Help
ECB president Mario Draghi questions the ECB's mantra of keeping inflation 'below, but close to 2%'. Draghi now favors ‘symmetry’ around the target.
The ECB staff is investigating Draghi's Proposed Inflation Targeting Idea as a means to achieve higher inflation.
European Central Bank staff have begun studying a potential revamp of their inflation goal, according to officials familiar with the matter, in a move that could embolden policy makers to pursue monetary stimulus for longer.
The staff are informally analyzing the institution’s policy approach, including the question of whether the current target of consumer-price growth “below, but close to, 2%” is still appropriate for the post-crisis era.
President Mario Draghi favors a “symmetrical” approach, meaning flexibility to be either above or below a specific 2% goal, the officials said, asking not to be identified as the work so far is confidential and preliminary. That would allow the ECB to keep inflation elevated for a while after a period of weakness to ensure price growth is entrenched.
Governing Council members were given a presentation by Massimo Rostagno, the ECB’s director general for monetary policy, on the effectiveness of the current target, according to one of the officials. Rostagno showed that a straightforward 2% objective would make it easier to raise inflation and price expectations, and reduce the need to push interest rates deeper below zero in the future.
Changing the goal itself would probably require a formal review, the officials said. An ECB spokesman declined to comment.
Absurd Discussion on Many levels
- Central banks are hell bent on producing inflation when they do not have any idea how to measure it.
- Instead of wondering how to achieve 2%, they ought to wonder if 1% or 0% is a better target or if they should have any target at all.
- If you cannot hit the goal, then raising the goal post in and of itself cannot possibly do a damn thing except make the target look even sillier.
- Worries over routine price deflation are patently silly.
- The idea that inflation expectations matter is silly in and of itself.
Similar Fed Nonsense
It's not just the ECB chasing its tail, many Fed governors also support higher inflation targets without understanding why or how damaging those target are.
1A: Measuring Inflation
Economists ignore asset bubbles in their estimation of inflation. Those bubbles are very easy to spot but in the drive for 2% the bubbles don't count. Only rent does. Inflation is well over 2% if the Fed would only count actual home prices.
2: Questioning 2%
Central bankers are hell bent on reaching 2% without ever explaining why and without understanding how to measure it. With poor demographics, increasing productivity, and global wage arbitrage, a 2% goal is especially counterproductive.
3: Raising the Goalpost
If you can't put the basketball in the hoop, raising the hoop logically cannot help. Yet, Rostagno claims to have shown that a straightforward 2% objective would make it easier to raise inflation and price expectations. The idea is laughable. Why not 4%, 8%, or 88%? Unless there are actual policy changes targets are useless.
4: Deflation Boogeyman
The Fed and ECB keep fighting the deflation boogeyman.
Yet, the BIS did a historical study and found routine price deflation was not any problem at all.
“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study.
For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?
5: Inflation Expectations - Stupidity Well Anchored
The Fed and ECB are huge believers in "inflation expectations" and other economic nonsense such as the Phillips Curve.
I commented on the Phillips Curve and Inflation Expectations in Economic Stupidity and Fed Groupthink Remain "Well-Anchored"
Like Mario Draghi, New York Fed President John Williams want to reconsider inflation targeting.
Hello Jerome Powell, We Have Questions
In his March 8 speech on Normalization and the Road Ahead, Fed Chair Jerome Powell spoke of diversity, zero-bound interest rate problem, and the Fed's path to normalization.
In his speech, Powell stated "Makeup strategies are probably the most prominent idea and deserve serious attention," while simultaneously admitting an "uncertain distance between models and reality".
The "makeup" strategy implies having a higher rate of inflation to make up for past underperformance vs a 2.0% target.
In an open letter to the Fed Chair, I penned Hello Jerome Powell, We Have Questions
Inflation Targeting Questions
- Given two certified bubbles that happened under 2% inflation targeting, why not a lower target of 1% or 0%, if any target at all?
- The implied assumption in the catch-up theory is that two errors are better than one. But how can it make sense to discuss makeup strategies when non-bubble inducing targets are not fully understood?
- Given the Fed has never spotted a bubble in real time, why should anyone believe we aren't in one right now?
- Demographics are deflationary. How does that justify a 2% inflation target or any other specific target?
- Prior to 1983, the BLS directly placed housing prices in the CPI. Had housing prices been in the CPI in 2004-2006, might not the Fed have been more aggressive in hiking? Doesn't the same apply more recently?
In his speech, Powell also said "Persistently weak inflation could lead inflation expectations to drift downward."
Why does it matter?
Scrutiny of elastic vs inelastic items in the CPI shows it doesn't.
CPI Percentage Points
Under "inflation expectations" theory, if consumers are convinced prices will go up, they will rush out to buy things causing an allegedly beneficial price spiral.
Inelastic Item Questions
Q: If consumers think the price of food will drop, will they stop eating? Will they eat twice as fast if they expect prices will rise?
Q: If consumers think the price of gas will drop, will they stop driving?
Q: If consumers think the price of rent will drop, will they hold off renting until that happens? Will they rent two apartments if they expect the price to rise?
Q: Will consumers delay medical services if they think prices will drop? Will they have two operations if they think prices will rise?
Elastic Item Questions
Q. If someone needs a refrigerator, toaster, stove or a toilet because it broke, will they wait two months if they think prices will decline?
Q. Better deals on TVs and computers are always around the corner. Does that stop TV and computer purchases?
Three Wrong Economic Models
- Deflation Group-Think
- Inflation Expectations
- Phillips Curve
At the top of the list of widely-believed but false central bank economic theories is the notion that falling retail prices are bad for the economy.
Central banks acting on those group-think beliefs attempt to modify inflation exceptions while not factoring in asset price appreciation.
Invariably, the result is bubbles.
Final Key Questions
Why does the Fed ignore asset valuation models that do work over the long haul in favor of economic models that admittedly have an "uncertain distance between models and reality"?
Why, Jerome Powell?
Today, the ECB marches further down the same illogical path.
Once again, I ask: Hello Jerome Powell, We Have Questions.
Can we please have a rational discussion?
Mike "Mish" Shedlock