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The fear of price deflation is moving the Federal Reserve in the direction of establishing an official “inflation target” that would be the goal of monetary policy. The fundamental problem with inflation-targeting is that it is the Fed would be shooting for an annually planned rise in prices and depreciation of the dollar.
The minutes of the December 2008 meeting of the Federal Reserve’s Open Market Committee say that Board members discussed the need for “a more explicit indication of their views on what longer-run inflation rate would best promote their goals” of fostering financial and general economic stability. Fed Chairman, Ben Bernanke has long been an advocate of formally setting an inflation target as a guide for monetary policy. In a book on Inflation Targeting that he co-authored in 1999, Bernanke argued that it has the benefit of establishing a longer-term goal to anchor people’s inflationary expectations about the degree of price stability over the years. At the same time, he argued that it should allow the Fed to have the shorter-term flexibility to accelerate or slow down the rate of monetary expansion if higher or lower rates of price inflation seemed warranted. The inflation rate target most often suggested, including by Bernanke, is around 2 percent per year. The idea is to have a range of positive price inflation in which the Federal Reserve can have wriggle room to manipulate the money supply and interest rates before the economy ever fell into price deflation. Price inflation-targeting eliminates the consumers' gain from rising productivity and greater output that normally would result in a trend toward falling prices--if not for the increase in the money supply. Such productivity-based price deflation has happened in the American past and was consistent with economic growth and general stability. Inflation targeting also builds in a continuing tax on the taxpayers' nominal wealth and cash holdings. With each passing year the real value of that wealth and cash holdings will diminish by the rate of decline in the value of the dollar has declined. Bernanke’s conception of anchored price expectations through inflation-targeting allows the Federal Reserve to have its cake and eat it too, by permitting simultaneous monetary rule and monetary discretion. On a day-to-day basis, this means that monetary policy and price inflation will be completely left to the arbitrary decisions of the monetary central planners running the Federal Reserve. Suppose that an inflation target is set by the Federal Reserve Board in 2009, and the target chosen is a 2 percent annual rate of price inflation. The graph, below, shows what this would mean over a 20-year period in terms of the general price level and the purchasing power of the dollar. 
Source: Bureau of Labor Statistics
If the Federal Reserve were to follow a 2 percent a year inflation targeting rule, the Consumer Price Index (CPI) would rise from 215.8 in 2008 (1982-84 = 100) to 327 in 2029. Prices in general would be 51.5 percent higher. At the same time, the dollar’s purchasing power would decline to the equivalent of 67 cents in 2029, for a 33 percent fall in its value . Even if market participants attempted to build in this anticipated annual rate of price inflation into their price, wage and loan contracts, they could have no assurance that their inflation expectations would not be frustrated.According to Bernanke’s “rule” for monetary policy, the Federal Reserve would continue to have virtually unlimited discretionary power to manipulate the rate of price inflation through varying rates of monetary expansion to further short-run policy goals set by the Fed’s Board of Governors. For example, between September and December 2008, the Fed’s monetary central planners have increased M-1 (cash and various demand deposits) by 40.2 percent and M-2 (M-1 plus a variety of savings and time deposit accounts) by 17.4 percent. If these rates of monetary expansion were not reversed, they would foretell a likely dramatic increase in price inflation in 2009 and 2010, and beyond. But virtually all macroeconomic schools of thought agree that there is no rigid and mechanically predictable relationship between the rate of monetary expansion and the general rise in prices over any given period of time. Thus, the Fed’s inflation targeting “rule” reduces to constant monetary tinkering and reversals of course caused by under- and over-shooting its own target. The monetary central planners would compensate and adjust for movements in the price level outside the “targeted” range, and undertake larger reversals when short-run circumstances lead them to initiate more radical shifts in monetary policy such as those of the last several months. Inflation targeting as proposed by Ben Bernanke and other macroeconomists reduces itself to basically more of the very same types of monetary policies that the Federal Reserve has followed over the past years, and which helped create the financial and economic crisis through which the U.S. is now passing. The question remains whether monetary central planning can ever work any better than many other types of socialist central planning. If the answer were to be “No,” then perhaps it would be time to reconsider the establishment of a real market-based gold standard with private competitive banking in place of paper money and government central banking.
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