Is it even possible for the FED to target inflation?

While Volker and Kohn are arguing about if the FED should have an inflation target of 2%, it is probably important to step back and see if it is even possible for the FED to have an inflation target! From Mich's Global Economic Trend Analysis:

No Agreement On How To Measure

I have the CPI at -5%. The Fed with its OER measure differs by 5%. That's a huge difference.

So how should housing be measured? I propose using Case-Shiller. Let's assume agreement even though agreement does not exist. The next question is: What weighting should housing have in the basket? The answer is I do not know, nor does anyone else. Certainly renters will feel differently about this than home owners.

What about property taxes? Those are not factored in at all. And certainly education expenses are a lot more important to someone with 4 kids in high school than someone else who is retired. Do we ignore food and energy or not?

What about asset prices? There is no question that inflation this go around was concentrated in housing prices and financials and last go around in Nasdaq stocks. Does anyone care to put a weighting on asset prices or do we ignore asset bubbles like we did in 1999-2000 and more recently 2005-2007?

Questions Impossible To Answer

I believe the above questions are impossible to answer. Assuming you agree, then it is impossible to select a representative basket of goods, services and assets to measure.

For the sake of argument however, let's assume one could pick a representative basket of goods and services and one could properly measure it. Now, what is the likelihood in a global economy for the Fed could actually manipulate interest rates and money supply to achieve its target? I contend that is impossible as well, and the actions of the Fed over the past two years proves it.

Three Fatal Flaws

1. It is impossible to pick a representative basket of goods, services and assets.
2. Even if one could by pure luck manage to do so, measuring that basket is in and of itself impossible.
3. Even if a magic fairy told the Fed what the basket was and how to measure it, it is virtually impossible for the Fed to tweak interest rates and money supply to hit that target.

There are simply too many factors in a global economy for the Fed to control prices that closely. Here are three of them: currency fluctuations caused by changing interest rate differentials, currency fluctuations caused by other central bankers printing money, increasing or decreasing demand for goods and services in emerging markets.

How anyone can possibly dispute those points? However, let's wave our magic wand one more time and suppose all three of those fatal flaws did not exist.

Would inflation targeting be a good idea? Of course not. The simple fact of the matter is inflation benefits those with first access to money (banks, the already wealthy, and government). By the time those on the lower socioeconomic scales have access to money, asset prices are inevitably too high for them to benefit.

Inflation Target Is Moral Hazard

Given that inflation benefits those with first access to money, any targeted inflation at all is morally wrong. Finally, for all this silly talk about inflation fighting and inflation targeting, its important to remember what inflation really is. Inflation is an expansion of money supply and credit, where credit is marked to market. Prices generally follow money supply but there is a variable time lag, productivity and consumer sentiment are huge factors, as are a host a host of global factors including interest rate differentials and currency fluctuations.

So even if the Fed could achieve that magic 2%, the whole shebang would eventually blow sky high anyway (as it just did) because wages will not keep up with prices causing asset bubbles to pop.