Monday, December 11, 2006

Long on Bernanke, short on Prescott 

Over the weekend the WSJ ran an op-ed by Marc Sumerlin (subscriber link) referring to Ben Bernanke as "the accidental inflation hawk." It is full of praise for Bernanke, awarding him an 'A' for his first year as chair of the Federal Reserve, making "fact-based decisions rather than strategy-based decisions," but saying that Bernanke has somehow not engaged in inflation targeting:
While economic growth was decelerating, there were no signs at that point that inflation was coming under control. In fact, wages were accelerating according to the available data, which usually gives a central bank more room to tighten. What is most amazing in retrospect is that the first Fed chairman ever to advocate inflation targeting was pausing as inflation was high and possibly accelerating. A key critique of inflation targeting -- one to which I still subscribe -- is that the target could in practice lessen the Fed's ability to look far down the road. But in this case, Mr. Bernanke was not a slave to the latest figures and bet that inflation would subside. So while a belief in inflation targeting has not added value to the decision-making process, it hasn't done any harm so far.
I hastily come to Bernanke's defense by noting that it isn't really inflation targeting but inflation-forecast targeting, or expected inflation targeting. The reason the Bernanke strategy has worked is because they have used inflation yardsticks and forecasts that have turned out to be reasonable. Sometimes, it may make you appear to be an inflation dove. But when done well it is actually quite bold, in both directions. You could look it up.

Now to some people like Ed Prescott, who knows a thing or two about economics, the debate over monetary policy is much ado about nothing. The last 25 basis points just doesn't matter very much. (Previous link for subscribers; Mark Thoma has captured most of the editorial, and makes comments on stabilization policy with which I agree.) But we can never be too certain: Monetary policy, we are reminded, works with long and variable lags. That makes forecasting all the harder, but it nevertheless seems workable. William Polley notes
Where monetary policy's effect on output is concerned, expectations matter. That is a fact which is not lost on Mr. Bernanke, especially these days.