My naivete about government officials
By Scott Sumner
Back in the 1980, I believed the Fed needed to target inflation or NGDP, and if they did so the problem of high inflation could be solved. These views were widely mocked by people on both the left and the right, for different reasons:
1. On the left they mocked Milton Friedman, who they claimed was obsessed with the view that money was the key determinant of inflation. They thought it obvious that the guns and butter policy of the 1960s ignited inflation, and that the peak periods of inflation represented supply shocks. They believed that the only way to control inflation was to control budget deficits. (That was before inflation plunged in the 1980s, during a period of very high peacetime deficits.)
2. On the right they talked about the “time inconsistency” problem with fiat money. Inflation was the inevitable result when you had governments facing re-election that had to worry about the unemployment rate. Of course the past 5 years provided a near perfect test—we had a government very worried about unemployment, which faced re-election in 2012. And inflation stayed low.
In the 1980s the government did bring down the rate of inflation, although even in the late 1980s it was still running in the 4% to 5% range. Then in the 1990s they focused on a 2% inflation target, and choose the PCE inflation index as their target. So I decided to compute the actual average rate of PCE (headline) inflation over the past 24 years. And it turned out I was wrong; the Fed did fail to hit their inflation target. Here’s the actual PCE inflation rate over the past 24 years:
Now what would the old Keynesians of 1980 say? Here are some possible explanations:
1. Since 1990, the Newt Gingrich/Nancy Pelosi/John Boehner regime has expertly steered inflation at roughly 2%, by skillfully adjusting the fiscal deficit.
If you’ve stopped laughing, let’s proceed to the next explanation:
The Fed got very lucky, and even more amazingly, the central banks of other major countries were also able to luck out at almost exactly the same time.
In contrast, those on the right seem to think 1990-2014 didn’t happen. Here’s something from the comment section of my previous post:
This is a pretty naive view of self control. Libertarians like to stress the imperfection and inevitable ignorance of man right up until their favored policy choices require Herculean efforts of virtue and restraint. At that point people are suddenly near perfect.
Silly me, for believing that central banks could improve their performance.
People on the right are stuck in the “bumblebees can’t fly in theory” rut, and liberals don’t even understand that central banks are steering the nominal economy. Liberals should have been bashing the Fed for tight money since 2008 and conservatives like Charles Plosser (who think it’s the Fed’s job to control inflation, not unemployment) should be smiling like the cat that swallowed the canary.
I’d also like to clarify a few issues that were raised in the comment section.
1. Some people like to compare the classical gold standard with the fiat money period. That makes no sense. Either compare the entire gold standard to the entire fiat money period, or leave out the bad gold standard of 1918-33, and leave out the (bad) pure discretion period of 1968-90. The price level has been more predictable (both short and long term) under the inflation-targeting regime since 1990 than it was during even the classical gold standard (1879-1914). If you had forecast the September 2014 price level back in September 1990, under the assumption the Fed would hit its 2% inflation target, you would have been less than 1% off. That was not true under the classical gold standard, when the price level was roughly a random walk.
2. People get dates wrong. The classical gold standard began in the US in 1879, and went up to 1914. The interwar gold standard lasted from 1918-1933. The quasi-gold standard lasted from 1934 to 1968. Nothing meaningful happened in 1971. We had already completely left the gold standard in 1968, when the market price of gold was allowed to float and foreigners could not longer redeem dollars for gold.
[Broken formatting fixed.–Econlib Ed.]