Volcker Blasts Bernanke and Yellen Over 2% Inflation Target

Volcker openly criticizes his Fed successors over inflation targeting. He is correct yet he did not go far enough.

False Precision

Paul Volcker wrote an op-ed for Bloomberg accusing the Fed of "false precision". On that score, as well as inflation targeting, his criticisms are accurate.

Please consider What’s Wrong With the 2 Percent Inflation Target by Paul Volcker.

In 1996, Federal Reserve Chairman Alan Greenspan had an exchange with Janet Yellen, then a member of the Fed’s Board of Governors, that presaged a major — and, I think, ill-advised — change in the central bank’s approach to managing the economy.

Yellen asked Greenspan: “How do you define price stability?” He gave what I see as the only sensible answer: “That state in which expected changes in the general price level do not effectively alter business or household decisions.” Yellen persisted: “Could you please put a number on that?”

Since then, under the chairmanship of Ben Bernanke and then under Yellen [the answer] has been translated into a number: 2 percent.

I puzzle about the rationale. A 2 percent target, or limit, was not in my textbooks years ago. I know of no theoretical justification. It’s difficult to be both a target and a limit at the same time. And a 2 percent inflation rate, successfully maintained, would mean the price level doubles in little more than a generation.

I do know some practical facts. No price index can capture, down to a tenth or a quarter of a percent, the real change in consumer prices. The variety of goods and services, the shifts in demand, the subtle changes in pricing and quality are too complex to calculate precisely from month to month or year to year.

It is also true, and herein lies the danger, that such seeming numerical precision suggests it is possible to fine-tune policy with more flexible targeting as conditions change. Perhaps an increase to 3 percent to provide a slight stimulus if the economy seems too sluggish? And, if 3 percent isn’t enough, why not 4 percent?

I’m not making this up. I read such ideas voiced occasionally by Fed officials or economists at the International Monetary Fund, and more frequently from economics professors. In Japan, it seems to be the new gospel. I have yet to hear, in the midst of a strong economy, that maybe the inflation target should be reduced!

The fact is, even if it would be desirable, the tools of monetary and fiscal policy simply don’t permit that degree of precision.

Amazing Discussion

Volcker goes on to blast the risks of deflation, noting "fear [of deflation] can in fact, easily lead to policies that inadvertently increase the risk.

Volcker accurately stats that the danger comes from encouraging inflation and its close cousin of extreme speculation creating bubbles and excesses threaten financial markets. Ironically, the “easy money,” striving for a “little inflation” as a means of forestalling deflation, could, in the end, be what brings it about.

Volcker's article is an excerpt from his upcoming book “Keeping At It: The Quest for Sound Money and Good Government,” by Paul Volcker with Christine Harper.)

End the Fed

The only thing Volcker missed is a failure to tackle the notion that there needs to be a central bank at all.

Otherwise, his rant is 100% spot on.

I have commented on this more times than I can count, for at least a decade. Here are a couple examples:

Economic Challenge to Keynesians

My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

BIS Deflation Study

The BIS did a historical study and found routine 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?

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

How Much is the CPI Understated?

In How Much is the CPI Understated? I made these inflation comments:

Of course, there is no such thing as a representative basket of goods and services in the first place.

Moreover, it makes little sense to average all the components the way the BLS does.

To top it off, the CPI fails to factor in clear bubbles in financial assets. Those financial bubbles are a direct representation of unreported inflation.

Bubbles Everywhere

As a direct result of the Fed's total incompetence in understanding inflation, bubbles are readily apparent in equities, in junk bonds, and in Bitcoin speculation.

Those bubbles will burst bringing about the very deflation the Fed hoped to prevent.

Mish on Inflation Targeting

  1. The Fed's Miserable Inflation Targeting Performance in Pictures
  2. Rethinking the Fed's 2% Inflation Target: Spotlight On an Absurd Debate
  3. Central Banks Rethink 2% Inflation Target (In the Wrong Direction of Course)

The lead image is from number 2 above. Please give it another look.

Bloomberg, the Financial Times, the Wall Street Journal, and the New York Times all turned down articles by me with nearly identical statements as Volcker made.

Mike "Mish" Shedlock

Comments (26)
No. 1-17
killben
killben

"As a direct result of the Fed's total incompetence in understanding inflation"

Add: The Fed's control over interest rates (theoretically they can set it at ZIRP, NIRP or whatever they see fit) and printing press to print money and buy anything they want to the extent they want and mumble some reason or other, some even diametrically opposite depending on what they want to defend at that point of time.

The Fed is nothing more than a bunch of scoundrels out to save banks from bankrupticies, bankers from jail term over the bodies of savers, retirees, prudent people (and soon people who have been forced into taking risks which they most likely would not have due to the demented policies of the Fed). What makes my blood boil is after having destroyed so many people's lives and made price discovery a joke, they were recently preening about having saved the world.

A more fitting action would be rope and lamp-post for these scoundrels.

Yancey_Ward
Yancey_Ward

The point of "2%" is pretty obvious- move the needle off of "price stability" which carries the connotation of "O%". Once you do that, then you can set whatever positive value you want, even if that "target" is one set in hindsight, which of course it would be.

FelixMish
FelixMish

CPI is an over-simplification, at best. Since the middle of the last century, manufactured goods haven't changed much in price, for instance. Sure, some manufactured items have as much as doubled in sale price. But electronics prices provide a heavy counter-balance to such items.

Ted R
Ted R

I wonder how many private jets the Federal Reserves owns these days?

Ted R
Ted R

It is time to finally audit the Federal Reserve.

27CAV8R
27CAV8R

I just can't get my head around this. How can something that "we" find so patently obvious and harmful (inflation targets, the Fed [or, all CBs], bubbles of all kinds, ZIRP, NIRP, QE, printed money, etc.) evade the reason of so many schooled economists? Maybe the phrase "schooled economists" has something to do with it.....How can Volcker see it and others can't? I just don't get it. I mean, only a fool can think that the last decades' monetary policy was generally beneficial. Surely our fine schools of economics didn't just pump out a bunch of fools that are oblivious to the cause and effect pain of their policies. Surely. I once saw an interview with Yellen in which she said, "I think we've done a pretty good job." Jesus.....

DFWRealEstate
DFWRealEstate

How can logic evade the reason of so many schooled economists? Simple. The Fed's economists (and many others) are paid very comfortable salaries to ignore the destruction of their misguided policies and ridiculously useless models.

Sechel
Sechel

Blame the dual mandate and hubris. The Fed Reserve is comprised of so called scientists who aren't even required to do simulations and case studies and practice their alchemy on the real world economy. To the extent we need a Fed the mandate should be as follows, "lender of last resort" and to maintain stable prices. Once you add to that the responsibility of promoting growth and be a regulator you've given them so may tails to chase they don't know what they are doing.

RonJ
RonJ

Yellen asked Greenspan: “How do you define price stability?”

Math defines price stability as ZERO inflation. The same price yesterday, today and tomorrow. For Yellen to ask Greenspan how he defined price stability was to ask him how he would lie about inflation being stable prices.

RonJ
RonJ

"It’s difficult to be both a target and a limit at the same time."

It is impossible, for that matter. The FED has failed to reach 2% inflation for years. When it hits 2% inflation it isn't going to just sit there, just as it didn't sit at any number as it moved up to 2%. Same with the full employment target. After a recession, it takes years to ever hit full employment and when it gets there, it is just about time for the next recession, as the economy is likely overheating at that point.

Effectively, the target becomes the reset point. Beware reaching the target.

RonJ
RonJ

"The fact is, even if it would be desirable, the tools of monetary and fiscal policy simply don’t permit that degree of precision."

Greenspan dropping the rate just 3/4 percent in 1998, during the Asian Contagion, blew the top off the Nasdaq, causing it to crash 76%, as well as creating the late 90's Clinton boom era, as he turned Americans into the consumer of last resort, to bail out Asia. This resulted in Greenspan raising the rate to 6 1/2%, ending the boom, which resulted in Greenspan crashing the rate to 1% and taking lending standards to ZERO in order to facilitate a housing bubble to replace the Nasdaq bubble with.

It was reckless behavior by the FED. Their reckless behavior continues.

KidHorn
KidHorn

The way the CPI is calculated almost guarantees and understated inflation rate. Hedonic adjustments and substitution of more expensive items for less expensive are an asinine way of calculating inflation.

If the FED were a doctor and you had a broken arm, they would claim your arm isn't broken because you now use your other arm exclusively.

abend237-04
abend237-04

Stupidity won't fix itself. Eratosthenes proved conclusively that the earth is round over 2200 years ago, but it was still hotly debated when Columbus sailed more than 1700 years later. The Dual Mandate is our modern equivalent. Congressmen and bankers sitting around a table cannot simply agree on a set of numbers for a flat earth economy. Madness.

Casual_Observer
Casual_Observer

Central banking is a farce and people know it. The only thing holding the US together is appetite for US dollars. This is the de facto reserve currency of the world. The risk of a madman soon controlling the world is higher and the dollar will go with it. Bernanke wanted to drop money from the sky. That would have been more effective than the Fed policy. There is very little money to keep the masses from going broke when the next recession hits. It will be worse than 2009. This time will be the worst seen since the 1930s.

Carl_R
Carl_R

As I have pointed out repeatedly, the calculation of the CPI has real world effects, because the government adjusts Social Security payments based on CPI. Thus, you can see visibly whether the official CPI is too high or too low over a long period of time by observing the standard of living of retired people.

During the 70s and 80s, the standard of living of people on Social Security rose dramatically, about 50-60% over 20 years, indicting that the CPI was about 2-3% a year too high. Adjustments were made to the CPI in the 90s to fix that. If people like John Williams were correct, reported CPI has been about 3% a year too low since about 1995. To test his theory, we can compare the standard of living of those on Social Security today to the standard of living of someone on Social Security in 1995. We would expect to find that the current standard of living has declined to .97^23, or in other words, to about half. Is the standard of living of these people half of what it was 23 years ago? If it was, you'd think they would notice, and AARP would be up in arms, but they aren't. That indicates that the CPI is not understated significantly.

The CPI is a poor way to measure inflation in any case. The GDP deflator is easier to compute, and doesn't require the constant adjusting. The adjusted CPI is now about the same as the GDP deflator, again indicating that the adjustments are reasonabe.

Kinuachdrach
Kinuachdrach

Central Bankers are like climate "scientists" -- playing with grossly over-simplified models manipulating highly dubious "data" and fooling themselves into believing they can make useful predictions about the real world.

Of course, we voters are strange too. We have an election coming up, and the folly of the Federal Reserve is not even on the radar of most voters (or almost all candidates, for that matter), even though it is much more important than transgendered toilets or whatever today's hot topic may be.

Advancingtime
Advancingtime

In a recent interview with Bloomberg the former ECB President Jean-Claude Trichet, opined about his outlook for the global economy and monetary policy repeating the line declaring 2% inflation the desirable goal. In a speech last week FED chairman Powell also declared this as the goal and said the economy appeared solid going forward. The article below delves into why all central bankers seem to say the same thing and if it is really true.