Thursday, November 15, 2007

More Bernanke genius

Today's WSJ:
Mr. Bernanke downgraded the Fed's reliance on so-called "core" inflation readings, which means a price basket without food and energy. Some of our friends joke that this core measure includes prices on everything except what people actually buy. We think it's mostly been a distraction that makes inflation seem lower than it is, and that the Fed should focus on the overall price level. So good riddance.

The second point is that the Full Employment and Balanced Growth Act of 1978 deserves to be repealed. Also known as Humphrey-Hawkins, this is the law that mandates that the Fed consider both price stability and full employment in making monetary policy decisions. Mr. Bernanke noted yesterday that this dual mandate makes it impossible for the Fed to target only inflation the way, say, the European Central Bank is mandated to do. It is in pursuit of this dual mandate that the Fed sometimes takes its eye off the prize of price stability, most recently with Alan Greenspan's decision to hold interest rates too low for too long this decade. We are now living with the housing and financial boom and bust consequences.

If Mr. Bernanke really wants to be "transparent," he'll tell us what lessons he and his fellow high priests have learned from this episode. The only official who's fessed up so far is Dallas Fed President Richard Fisher, who in a brave 2006 speech blamed "backward looking" inflation data for persuading the Fed to stay too easy for too long.

We think the Fed's mistake was watching lagging indicators like "core inflation" through the rear-view mirror, even as more forward looking market indicators like asset and commodity prices, as well as the declining dollar, flashed red. More openness is nice, but setting monetary policy by a genuine price rule would be better.

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