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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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Human nature is on the whole good. If it were not, evil men would jail and slaughter good men and any hope of civilization would have died out long ago along with the human race itself. The whole idea of human nature as weak and grasping, or whatever Mr. Munves unstated idea might be, is invalid and unproven.
No justification for regulation by the government can be found. Just think if Mr. Munves notion were correct. Why, then we would have weak and grasping men regulating weak and grasping men. Then, we’d need another layer of such examples of human nature, as Mr. Munves sees it, to regulate the other men and so forth. Unworkable.
Human beings need to be free to live their lives as they see fit. In this context, this means the government must be separated from the economy just as government and religion were separated a few hundred years ago. Removal of the economy from the government is mankind’s next step toward freedom.
Debasing currency (usually through inflation) is governments' main tool to finance wars, social welfare programs and corruption.
The banks are not run properly precisely because of the existence of the FDIC. I assure you they would be a lot more careful if the government did not guarantee loans. If lenders want assurance let them purchase insurance from competing insurance companies and not the involve the state. Not to mention the FDIC doesn't have the money either; they invent it out of thin air.
A "smaller economy" may just mean we won't have bubbles form and the subsequent destruction that always follows.
All the problems with inflation targeting pointed out by Mr. Ebling are perceptive and obviously true. The comment about targeting being the equivalent of government central planning is also true and obviously a problem.
Of course the goal is to match the paper money or credit creation to the level of natural economic activity based on resources available, actual output, efficiency of output and relative demand so prices can rise or fall or remain the same based on natural market forces rather than being skewed by the creation of too much or too little money or credit.
If we go to a market-based gold standard with private competitive banking, obviously it must be fractional reserve banking or the money supply would be too constrained to permit the amount of economic activity that is possible on a responsible basis (or maybe it is not obvious but I think this is true).
The problem with private banks issuing money based on their own gold reserves is that it would be tough for an individual or merchant to know whether the bank issuing the bank note had gold reserves to back up the note. Imaging a New Yorker going into a store in Florida with bank notes from a local New York bank. How does the Florida store know if it is good. Should banks be required to keep enough gold to redeem 100% of it the notes it issues? What happens when depositors want their deposits back in gold?
Also, given the period bank panics that occur as a result of human nature, even properly run banks would be at risk unless there are government guarantees of deposits (like the FDIC) in which case the banks have to be closely monitored to make sure they have sufficient reserves and are making only prudent loans so the government does not get stuck making good on irresponsible loans to the bank's cronies. But then you are back to the government running the system. So they might as well issue the money and credit as well. They just need to do it responsibly - a challenge they have not met of late.
If we want to have a governor on government creation of credit, the gold standard would do it but the government would be subject to the run on the bank problem where everyone wants their gold because they know there is not enough gold to cover all the currency. It is the same problem as you have with private banks. It seems to be part of the human nature.
I am not sure what the answer is. Maybe it is private banking issuing paper money and credit with no government guarantee. But if so, we will likely have a much smaller economy.
(By the way, if in 2029 the dollar is only buying what $0.67 buys today, I think that's a 33 percent decrease in purchasing power, not a 43 percent decrease.)
When inflation explodes, how about a tax on every bank transaction to pull excessive currency out of circulation?
LEH