Target The Forecast

From Adam Posen’s talk (PDF) on monetary policy in the UK:

What British households have suffered in this regard [i.e., in terms of inflation] over the last year, however, is a decline in their purchasing power due to one-time factors that is neither amenable to reversal through monetary policy nor going to feed a more general rise in prices and wages. The MPC would only make things worse by making policy looking in the rear-view mirror, trying to make up for past mistakes, especially given the fact that the underlying trend inflation rate is below target.

His point is that the price level rose thanks to a VAT hike and a currency devaluation, rather than to an overheating of the British economy’s productive resources. The logic seems compelling to me, but what’s worth pointing out is that the point about rear-view mirror policymaking seems compelling as a general matter and not just in terms of this particular case. One of the slogans I’ve picked up lately from economics blogs is the idea that monetary policymakers ought to “target the forecast,” i.e. explicitly stop paying attention to past performance and instead look at market measures of inflation expectations.

This should help keep things nicely contained and stabilized. If you explicitly say your objective is to keep market expectations of long-run inflation at around two percent (or whatever) then two good things come from this. One is that if expectations deviate from your target, investors are going to say to themselves “at the next meeting, these guys will act to bring expectations back in line with the target, so we should buy/sell before then.” That on its own will bring expectations back in line with the target, allowing you to spend your meeting issuing self-congratulatory statements about your own credibility without actually doing anything. The other is that this eliminates the current ambiguous status of the central bank’s self-published macroeconomic forecasts. Right now, when the Fed says growth is going to be such-and-such next year, that’s supposed to be a prediction, but it kind of seems like a self-fulfilling prophesy. Either that, or the Fed is for some reason forgetting to take the Fed into account when writing its own forecasts.