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The Fed's 2% Inflation Target: The Ultimate Keynesian Con Job

Submitted by David Stockman via Contra Corner blog,

The old adage that if something is repeated often enough it is soon assumed to be true couldn’t be more apt with respect to the Fed’s 2% inflation target. Last week, Bloomberg had a piece that did exactly that, describing how “Federal Reserve officials are hunting for new tactics to raise price increases to their target”  because “inflation is descending toward the danger zone”.

In fact, the September meeting notes cited several officials who worried that “inflation might persist below” the committees target for “quite some time.” Accordingly, the Bloomberg author, Craig Torres, pulled out his editorial pen and offered his opinion as if it were objectively obvious:

The Fed needs a clear strategy for getting the inflation rate higher after falling short of its 2 percent target for 28 consecutive months.

Well, now. Twenty-eight straight months of misses. Let’s see, even using the Fed’s systematically understated measure of inflation, the PCE deflator ex-food and energy, consumers’ savings and paychecks have lost 3.3% of their purchasing power during the last 28 months.

Apparently, had they instead suffered a 4.7% loss of purchasing power (2% inflation for 2.33 years) everything would be copasetic. Instead of remaining in a funk, as has been evident since it unexpectedly snowed last winter, they would have been spending up a storm. Presumably the US economy would have long ago hurtled through that pesky “escape velocity” barrier.

Isn’t it amazing that over the relatively brief period in question that shrinking the purchasing power of the dollar by 4.7%% versus 3.3% could make such a profound difference. Or maybe not.

But don’t expect the “journalists” at Bloomberg to even ask. Like their “competitors” at the WSJ and Reuters, they are about as mainstream, lazy and intellectually sloppy as they come. In this case, it is not likely that a writer who cites two ex-central bank true believers as his main source—-former Fed governor and macro-model peddler, Larry Meyer, and former Bank of England policy committee member and current Keynesian snake oil salesman, Adam Posner—-would trouble himself with proof that a 2% annual gain on the CPI is a proven economic elixir.

No, the 2% inflation mantra has been repeated so early and often by Fed speakers, their court economists and the Wall Street stock peddlers known as “strategists” that it appears to amount to the monetary equivalent of the Pythagorean theorem.  Even then, the literalist presentation of the matter in the Bloomberg story sets a new standard for credulity.

Supposedly, if inflation is a tad on the weak side, or even remotely veers off in the direction of the dreaded “deflation” zone, consumers will sit on their wallets waiting for prices to fall further. Soon you are sliding down the slippery slope into the maws of a deflationary malaise, and then Great Depression 2.0. So Bloomberg even found a consumer to illustrate this point.

It was a rather prosperously proportioned lady in an appliance store who would apparently be put out of a buying mood if prices were not increasing with sufficient vigor. And Bloomberg even included that proposition in the caption, lest any reader miss the point:

Consumers anticipating falling prices may postpone discretionary purchases. This can combine to create a vicious circle of less spending and further downward pressure on prices.



So it must be true. Its right there in the (online) papers.

For the life of me, therefore, I can’t figure out how the Apple shoppers pictured below are still even functioning. Prices of their favorite i-Gadgets have been falling for years—but here they are lined up an Apple Store as far as the eye can see fixing to spend up a storm.

Ok, digital age products are different. I get that. Not only do their prices drop consistently, and sometimes even plunge precipitously, but they also give you huge increases in function and quality. So what’s involved, apparently, is some kind of consumer addiction to getting more bang for the buck in this allegedly idiosyncratic corner of the marketplace.

Unfortunately, that doesn’t explain the graph below which is distinctly not new age, but the BLS wholesale price index for all finished consumer goods less food. Year-in-and-year-out since Alan Greenspan’s arrival at the Fed in August 1987, it has risen at relatively consistent annual rate—- averaging 2.4% over the 27 year period as a whole. The occasional minor dips in the rate of increase have absolutely no correlation with consumer spending rates over the period.

The only serious dip is during 2008-2009 when the oil price plunged from $150 per barrel to less than $40, and took the whole index with it. But consumer spending skidded during that period due to the fact that jobs and incomes were plunging owing to the Great Recession—- not because oil prices were crashing from speculative peaks that were undone by the laws of supply and demand.

What is embodied in the above chart is actually the “stuff” sold at Wal-Mart outside of the food department—where presumably people need to eat whether prices are rising or falling.

As it happened, Wal-Mart’s slogan was not “everyday rising prices” but “everyday low prices”. During the 27 years pictured above, it is absolutely certain that Wal-Mart’s average prices did not grow anything close to the 2.4% CAGR embedded in the BLS index. Yet its domestic sales nevertheless soared by orders of magnitude more than the growth of consumer spending during the same period.


In fact, nominal PCE grew at an annual rate of 5% during the period or by only two-fifths of Wal-Mart’s 12+% CAGR. That is, as a result of scouring the earth for the lowest prices available, its market share of the American consumer’s wallet rose dramatically. Low and often falling prices did not drive consumers away; it attracted them in droves.

The Wal-Mart saga alone knocks the 2% inflation story into a cocked hat. The latter is a complete myth made of whole cloth.

Indeed, the very idea that the hard-pressed main street consumers of America - most of whom have virtually no discretionary income to spend after the basics anyway— will go on a buyer’s strike if they don’t get enough inflation is just plain ludicrous.

That Keynesian central bankers peddle this nostrum with a straight face is amazing in itself, but it is at least understandable because it gives them a reason to keep the printing presses humming. That journalists like Mr. Torres at Bloomberg repeat it with no questions asked is even more remarkable. It proves that the impending replacement of financial journalists with robo-writers may not be so bad after all. It won’t make any real difference.