Friday, September 15, 2006

Whose Ox is Being Gored?

Bloomberg's Caroline Baum has a fantastic assessment of the current US monetary policy. Some of it gets a little wonky, but it is well thought out.

The main point is how long the Fed has been inclined to strip out "volatile" food and energy.

Recently some soft but solid voices have started to challenge the Fed's choice of a core index, in part because oil prices have been ``volatile'' in one direction -- up -- for most of the last three years.

But there was also this passage that struck me a certain way:

U.S. policy makers have long defended the practice of using a core inflation measure as a check on how they're doing. The public, of course, sees this as just another gimmick the government uses to pull the wool over its eyes.

The concept of stripping out historically volatile food and energy prices from inflation indexes is ``an issue of trying to forecast more effectively the overall inflation rate,'' Federal Reserve Chairman Ben Bernanke explained in the Q&A following an Aug. 31 speech in Greenville, South Carolina.

A second reason for targeting core inflation ``has to do with policy making,'' he said. In order to offset the immediate effect of an increase in energy prices, the Fed would have to ``force down wages and other prices quite dramatically to keep the overall price level from rising,'' he said. The alternative is to allow ``first-round effects to pass through'' and try to ensure that the energy-price spike doesn't pass through to other prices and wages.

Stop and think about that for a moment. Out of 300MM Americans and/or 6 Bln inhabitants of planet Earth, a handful of politically appointed economists get to decide who has pricing power, not to mention what a complex $12 Trillion economy can handle in the way of full employment, cost of funds, and so forth, as well as all that flows from said targets.

Where is it they say the road leads that is paved with good intentions?


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