The Fed Should Be Careful What It Wishes For
CAMBRIDGE – Empirical relationships in economics are sufficiently fragile that there is even a “law” about their failure. As British economist Charles Goodhart explained in the 1980s, “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” Central banks in advanced economies have recently been providing a few more case studies confirming Goodhart’s Law, as they struggle to fulfill their promises to raise inflation to the stable plateau of their numerical targets.
Major central banks’ fixation on inflation betrays a guilty conscience for serially falling short of their targets. It also raises the risk that in fighting the last war, they will be poorly prepared for the next – the battle against too-high inflation.
Consider the United States Federal Reserve, which at the beginning of 2012 quantified its Congressional mandate of “promoting maximum employment, stable prices, and moderate long-term interest rates.” These goals would be best achieved by keeping inflation, measured by the Fed’s preferred personal consumption price index, at 2% in the long run. Since then, the four-quarter growth in that index has been below this target in every quarter but one, as Fed forecasts of inflation consistently fell short of the mark. Goodhart’s Law still has teeth.
The Fed’s solution to this failure, like that of other central banks, has been to talk more about the subject. The minutes of the January meeting of the Federal Open Market Committee (FOMC) reveal an extensive discussion among policymakers about how to determine US inflation.
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