Targeting inflation

Even a casual reader will realize I ain't no economist. But I do share one trait with them: I'm not afraid to show my ignorance, either, gussying my opinions all up in a self-rationing construct that suggests science but screems art, especially the kind that is in the eye of the beholder.

And so, on the greatest authority of my own delusional observations, I'll put on my Great Carsony turban and offer my thoughts on inflation targets.

In Australia, the Reserve Bank has specified an acceptable inflation zone of 2 to 3%. If "it" stays in that range, don't expect them to be messing with interest rates.

In the US, there is much discussion and conjecture whether Bernanke will adopt a targeted inflation number or refuse to do so, as many suggest was Greenspan's preferred option. I'll try to paraphrase something I think I heard CNBC’s Senior Economics Reporter, Steve Liesman, say the other night in describing his view of Greenspan. He said Greenspan was of the view that economics is not physics (shock, horror: not SCIENCE?!), and that there was no speed-of-light benchmark that could be used at all times in all circumstances to set an "appropriate" inflation rate. As Peter Hartcher puts it, "His [Greenspan's] core objection, however, is that a formal target would rob him of the freedom to act as he sees fit.

Hartcher adds, "Many Fed watchers expect Bernanke will introduce a formal inflation target for the Fed of 2 per cent, plus or minus a percentage point.
But this is a distinction without a difference. Academics concluded years ago that the Greenspan Fed has been aiming for inflation of 1.8 per cent." (http://www.smh.com.au/text/articles/2005/10/25/1130239521908.html)

My contribution to this discussion is that, whether there is a fixation to a "target" or whether they reserve a royal perogative over interventionist discretion, in the real world the central bank actors will always fudge, prevaricate and prognosticate. This opinion is based on two observations.

First, notwithstanding what they say, they always reserve some "viggle" room about just what it is that they mean by the "inflation" they're targeting. Through various metrics they come up with different scores for inflation, including deflators, PPI, CPI, core and headline. By choosing one goalpost over another, they change the target. In the current climate, there is considerable doubt as to whether the recently preferred core rate "suitably" accounts for the "real" rate, or whether aspects of the headline rate are "spilling over" into the core. What that means is that, target or no target, they are feeling their way by the seat of their learned pants.

The second thing that matters is that inflation, real inflation, is not a static number. We measure it as a snapshot. We make a record of some kind at some point in time and call that inflation. In that way it looks like a fat, juicy bullseye target sitting on a archery range. That kind of static analysis gives some economists the chance to say, even though the accepted inflation figure is right up against the limits of the inflation target, "no worries, mate".

"With no hard evidence of a widespread petrol price spillover, economists expect interest rates will remain on hold for the rest of the year. But after that, they remain split on when, not if, the bank will lift rates. An interest rate strategist with Macquarie Bank, Rory Robertson said any rate rise remained a long way off, "maybe in 2006, maybe not", adding that the importance of the headline inflation rate had become "widely overstated"." http://www.smh.com.au/news/business/petrol-pushes-inflation-to-the-limit/2005/10/26/1130302838570.html

But inflation is not an archery range target, it is a duck on the wing. It has speed and direction and a proclivity to change one or the other that has to be taken into account. Any central banker has to have a good eye, steady trigger finger and a gut feeling for "Kentucky windage" to hit that kind of target.

And so, even though Australia has a targeted inflation zone and inflation which has not so far been measured outside the acceptable limits, today's inflation is playing duck if not chicken with the central bankers. My inclination is to go with the guys who feel inflation is heading off target, outside the zone.
"[S]ome expect the bank could reintroduce its tightening bias as soon as next month when it makes its next statement on monetary policy. The chief economist at Commonwealth Bank, Michael Blythe, said evidence was already mounting of a second wave of inflationary effects from petrol prices, pointing to increased airline surcharges, milk prices, employer wage expectations and a recent pay rise awarded to NSW contract drivers. "Higher fuel prices are filtering through … but the proverbial smoking gun is yet to be found," he said." (Id.)

And I'll be interested to see how this turns out: http://guambatstew.blogspot.com/2005/09/this-may-interest-you.html