In defence of the inflation target

Adam at the TUC thinks pure inflation targeting is a bad idea. We should, he says:

Rewrite the remit of the Monetary Policy Committee to allow it to balance growth and employment against inflation when setting interest rates rather than focussing on inflation alone. This could be a temporary measure based on the principle that the remit was never written with a stagflationary period in mind.

I’m not sure about this, for four reasons.
1. The MPC can already do this. For one thing, when it foresees weaker growth (as now) it holds interest rates down, simply because slow growth leads to lower inflation. Also, the MPC does accommodate stagflation, in the sense that it tolerates rises in inflation in response to temporary shocks such as higher oil prices. As the Bank says:

A target of 2% does not mean that inflation will be held at this rate constantly. That would be neither possible nor desirable… Instead, the MPC’s aim is to set interest rates so that inflation can be brought back to target within a reasonable time period without creating undue instability in the economy.

2. If financial markets thought the inflation target would be relaxed in bad times, they’d require a higher inflation risk premium in gilt yields. And this would be unwelcome in two senses. It’d make it more expensive for the government to borrow in hard times, thus increasing the costs of fiscal stabilization. And it’d raise the cost of capital, thus - at the margin - depressing investment and growth.
You might object that the US copes well enough with the Fed having the dual objectives of promoting employment and keeping inflation down. But it has the luxury of being able to attract very cheap finance. It’s a little tougher for the UK.  
3. Stabilizing GDP is not enough, even if it can be done. Even in stable economic times, tens of thousands of people lose their jobs each week. Macroeconomic stability, then, does not achieve what really matters, which is security for individual workers. This requires better pooling of risks, either by the state or markets.
4. Every single worthwhile socialist objective - greater equality, the extinction of the boss class - can be achieved at low inflation. So there’s no gain from tolerating higher inflation.
Update: Frederic Mishkin agrees with me.

Comments

[Laban]

"... Every single worthwhile socialist objective - greater equality, the extinction of the boss class ..."

Surely by "extinction" you mean "replacement" ?

[passer by]

When I was a kid politics and economics was talked about in tens and hundreds of millions, then through my early adult life this turned into billions, and now we are into the trillions.

So I wonder for my remaining years has the great economic gods come up with some thing larger. Is it Zillion next? will it be 1000 trillions? (as opposed to the math system of a billion billions?)

So how I think the inflation target will be an aspiration in a few short years.

[Adam Lent]

Very interesting post. I'll ruminate and digest and reply on the Touchstone site once I've got a post about the PM's speech out of my system.

[Mr Art]

"Every single worthwhile socialist objective - greater equality, the extinction of the boss class - can be achieved at low inflation."

Don't a lot of people still believe in the Philips Curve? So on that model, low unemployment can't be achieved wihtout high inflation (if you think the last 20 years didn't falsify the theory)

[citoyen]

Hi;

It's the first time I make a comment here and english is not my mothertongue, so I apologize in advance.

Although I generally think that inflation targeting is a great thing; I got somehow convinced by Joe's article http://www.project-syndicate.org/commentary/stiglitz99

Your argument about signalling a strong commitment for low inflation is not valid if inflation is not a monetary phenomenon.

[kinglear]

every single worthwhile socialist etc...The extinction of the boss class would lead to a system rather like that of the Confederate Army in the American Civil War, and we all know how that eneded.More importantly,greater equality should be brought about by levelling up, not levelling down.

[dearieme]

passer by, do remember that the billion is smaller nowadays.

[Bob B]

Well done, S&M. A robust defence of inflation targeting is timely and surely needed.

The current vogue in places for mooting an end to inflation targeting will tend to stoke up inflationary expectations, which leads lenders on to seeking higher nominal interest rates and trade unions to demands for wage increases. That is why inflation soared in the 1970s in response to the hike in oil prices in 1973/4 and the rise commodity prices.

[ejh]

"More importantly, greater equality should be brought about by levelling up, not levelling down"

I agree with this and am looking forward to being levelled up to somewhere in the region of Richard Branson.

[ejh]

[Mind you, Orwell didn't:

"then there is the outer-suburban creeping Jesus, a hangover from the William Morris period, but still surprisingly common, who goes about saying ‘Why must we level down? Why not level up?’ and proposes to level the working class ‘up’ (up to his own standard) by means of hygiene, fruit-juice, birth-control, poetry, etc. Even the Duke of York (now King George VI) runs a yearly camp where public-school boys and boys from the slums are supposed to mix on exactly equal terms, and do mix for the time being, rather like the animals in one of those ‘Happy Family’ cages where a dog, a cat, two ferrets, a rabbit, and three canaries preserve an armed truce while the showman’s eye is on them."]

[passer by]

Dearime, My Boss Class has informed me (the wife) that under the short scale system we will get quadrillion (a thousand billion) Next.

Which off the top of my head, current US budget is 1.2 trillion? so 5% growth for 137ish years would get the sum up to around the quadrillion mark?

Are we not kind to the unborn, mind you I guess being born 10 years ago might give you a chance of seeing it, maybe a black swan will appear and I might see it?

So the politicos will be happy that imposing the inflation tax has much further to go, and I am sure it will, and as this tax hits the poorest hardest, the equalities will widen.

[多层实木地板]

Which off the top of my head, current US budget is 1.2 trillion? so 5% growth for 137ish years would get the sum up to around the quadrillion mark?
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