Central banks cannot control interest rates, even in the short-end of the market, except temporarily. The effect of a series of temporary pegging operations is indirect, and varies widely over time, and in magnitude. The effect of tying open market policy to an interest rate target is to supply additional (and excessive) legal reserves to the banking system when loan demand increases….. I.e., inflation targeting should be abandoned for this reason.

Stiglitz was quick to identify the problem, & quick to leave it begging (1) what is an acceptable inflation rate & (2) how should price indices be weighted?

Total legal reserves were inflated at a 15% annual rate in the last 6 months of 1980. When Volcker sent nominal gnp to 19.2%, he caused the FFR to hit 22.4% in the 1st qtr 1981. This particular 1970 event’s appellation was “time bomb” – forewarned. Thus Volcker laid the foundation for (the end of usury rates), i.e., payday loans and unrestricted credit card rates in 26 states.

If Bernanke was using a non-borrowed reserve target today there would be no offsetting sales of Treasury securities, reverse repurchase agreements, Treasury redemptions, etc

And Friedman: (1) no money figure standing alone is adequate as a guide post to monetary policy. (2) velocity isn’t a constant and his use of the income velocity figure isn’t valid. (3) The money supply is in constantly flux. (4) it should have been obvious that the DIDMCA would cause a shift from the narrow definition of money into interest bearing accounts – M2 (i.e., the elimination of Reg Q ceilings). Therefore the Fed would receive false signals using M1;

Beyond calling for abandoning inflation targeting and diversion of crops for biofuels, prof. Stiglitz has few concrete ideas in this article.

I am not sure I entirely agree with his proposition. When it comes to food and energy prices, if supply cannot go up in the short-run, demand can be and should be restrained. This applies in particular to energy.

Just as he questions the cost of fighting inflation (rising unemployment), i wonder if there is an implicit understatement of the costs of inflation itself.

Central banks all over the world – with or without government pressure – are too reluctant to have a recession. In my view, for many reasons, we need one in the world. To cite just one reason, resources are too tight. Growth just cannot go on at the pace of last five years.

Central banks can make that (recession) happen, if they wish to. But, they are scared that it would spiral out of control.

This ties in neatly with the theme of the paper, “Mirage of fixed exchange rates” (1995) by Obstfeld and Rogoff: it is possible to have fixed exchange rates but sometimes it could be too costly.

Similarly, if they believe in the need for a recession, central banks can have it but they wonder if they would pay too high a price for it.

The price that they are paying and are willing to pay to keep growth up, is inflation either because they want growth at all costs or, are miscalculating that inflation costs won’t be too much.

Methinks they are going to be very wrong on this one. In other words, it is going to be seriously unpleasant either way.

Have a nice weekend!

The price increases will be hard on almost everyone, but it will take a functioning economy to deal with the energy problem in a way that doesn’t consign the bottom 20% of our people to a permanent Lima-style slum hell.

Bernanke’s job is to keep an economy alive through a painful and expensive transition to alternative energy and slow to non-existent growth. He has to try to contain genuine inflation (and he’s doing that by doing what he can to shrink money supply) without using unemployment to contain price increases that are not due to inflation.

Moe Gamble

Inflation in the US is NOT 3%. Its 7.x% or 11 % depending on whether you use a 90s standard or a 70s standard.

This undermines the argument a great deal.
-K

So much for theory. In practice, all it did was strangle the economy until stagflation was broken. But it labor power too, and so from 1982 to the present, aside from a short interlude in the late 1990s, productivity has run well ahead of wage earnings.

And the way around -that- trap was the successive asset bubbles: first equities, then mortgages, and now, possibly, commodities.

Meanwhile the Fed, which regulated and sometimes bothered to oversee most financial institution footings in 1982, now has direct control over nominally perhaps 20%. From too much to too little.