Willem Buiter writes:
FT.com | Willem Buiter's Maverecon: It has taken a while, just under two years since Ben Bernanke took over from Alan Greenspan as Chairman of the Fed, but the deed now is done: the Fed has moved to de-facto inflation targeting... inside the twin Trojan horses of improved communications and greater transparency. An indeed, these proposals are likely to improve the clarity of the Fed’s communications to the market and the public at large and to enhance its transparency. But there is more....
The Fed’s modus operandi under Greenspan could be described as formally symmetric but in fact biased towards low unemployment, extremely flexible inflation targeting without a firm, let alone a numerical, inflation target.... There can be no doubt, however, about another asymmetry in the reaction function of the Greenspan Fed. With unemployment at or near the best guestimate of the natural rate, when faced with the choice between a rate cut that would reduce the likelihood of an increase in the unemployment rate at the expense of a higher risk of excessive inflation, or tighter monetary policy that would increase the likelihood of higher unemployment but would lower the risk of excessive inflation, the Greenspan Fed would opt for lower unemployment.
This is no longer true for the Bernanke Fed.... [T]he new three-year horizon for the forecasts will provide the equivalent of a numerical point inflation target.... The Fed will no doubt continue to pay lip service to what is deemed (both by the Fed itself and by Congress) to be its official, legal dual mandate - maximum employment and stable prices. Congress will continue to insist on parity for these two objectives, and Fed officials and Governors will nod and agree....
During the 32-year period 1965-2007, the headline CPI increased 24 percent more than the headline PCE index, an average annual difference in inflation rates of around 0.67 percent. the core CPI increased 28 percent more than the core PCE index, an average annual inflation rate difference of 0.77 percent. A core PCE target of 1.75 percent therefore would correspond to a core CPI target of 2.5 percent...
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