Assumption Error in Inflation Measurement

Chicago Trib. Classic example of how a HOT system breaks down:

Yet for all those profound concerns, the government reported last week a net drop in the measure of inflation most closely watched by the Federal Reserve, leaving people to wonder how that number can be falling when everything from a tank of gas to hamburger meat is sky-high. In fact, the official view of inflation for years has taken little account of food and energy prices, which are thought to go up and down with no lasting impact.

But evidence is growing that these basics could be elevated for years to come, and the "core" inflation rate—minus food and energy—is telling only part of the story.

"It is reassuring to have the core index tame, but you can't eat on the core index. You can't drive on the core index," said Bill Hummer, chief economist at Wayne Hummer Investments in Chicago. "You can't ignore what's going on in food and energy."

As if the Fed had tools that could actually slow commodity price inflation driven by a global economy. This is where monetarist policy breaks down.

Comments

[fairhavenhorn]

I wouldn't call it "breaking down". You need to decide what the goals of your policy are first, before claiming failure. Monetarist policy goal is not the elimination of inflation. It's the elimination of the government monetary manipulations from inflation.

The underlying theory behind this goal is that prices will reflect the underlying supply and demand fluctuations if the monetary manipulations are removed. This permits price to then be used as a simplified approximation for the combined impacts of the thousands of constantly changing elements of supply and demand. That is one reason to eliminate commodities and energy from the targeted inflation index. They have huge supply and demand swings that greatly confuse monetary stabilization. If you assume that monetary manipulations affect them to the same extent as other goods, then it is OK to ignore them and target stability for the other goods. This would eliminate the monetary influences and leave behind the wild swings due to supply and demand changes.

So your final paragraph reflects a disagreement with monetarist policy goals. They never intended to eliminate price inflation due to changes in supply or demand.

The rationale for eliminating the effects of monetary manipulation is the theory that if prices accurately reflect underlying supply and demand changes, then responses to price changes will appropriately adjust the supply and demand within the economy. (Basic monetary policy does not incorporate the substantial problems that result from long and mismatched response times, etc. These can drive an otherwise stable system into violent oscillations. It's one of the problems with a purely monetarist approach.)

The Fed has never been purely monetarist in its methods nor has it been purely targeting inflation. It has been just as interested in stable financial markets and other goals.