A History of the Federal Reserve, Volume 2 Read Online Free Page A

inefficiencies resulting from the time-consistency problem” (promising one thing but later doing another) (ibid., 1). Otmar Issing, former chief economist and board member of the European Central Bank, expressed a similar position on many occasions (Issing, 2003, for example). He regarded as impossible in practice the idea of following a fixed rule.
    The chapters that follow show that the Federal Reserve changed its objectives and its target many times. Often it did not have a precise target. Even after Congress required the Federal Reserve to announce an annual monetary target, it did not adopt procedures to achieve the target and allowed excess money growth to remain by following the practice called “base drift.”
    Table 1.1 from the 1980s shows the changing objectives pursued during 1985–88. The principal objective changed frequently, making it difficult for the public to plan. The Federal Open Market Committee (FOMC) did not announce the objectives at the time, and the statement of objectives was sufficiently vague that knowing the objectives would not help observers to anticipate policy actions. And because it chose four or five objectives, the public could only guess the relative importance of each or its influence on Federal Reserve actions.
    By the 1990s, principal central banks followed King’s “constrained discretion.” Many used some version of Taylor’s (1993) rule as a guide, but they deviated when they chose to do so. Several adopted inflation targets and gave more information about proposed actions and objectives. None followed a precise rule.
    Definition of Inflation
    Economists use two definitions of inflation, and laymen use some others. Monetarists define inflation as a sustained rate of change in some broad, general price index. The more common definition includes all price increases. Popular usage includes some relative price increases such as wage, asset price, or energy price increases; an example is “wage inflation.”
    Economic theory does not prescribe the choice of a stable price level over a stable sustained rate of price change. The former requires central bank policy to roll back or push up the price level following an event that raises or lowers it. If this is successfully carried out, the public can expect an unchanged price level over time. It incurs a cost because price adjustment is costly, particularly if the price level increased following a large increase in the price of oil or in an excise tax on a subset of goods.

    The monetarist position lets the price level become a random walk. Energy price, excise tax increases, currency depreciation, or reductions in productivity raise the price level; opposite movements reduce the price level. These changes up and down often are spread through time. They appear as changes in the rate of price change, but they are not sustained.
    Sustained money growth in excess of output growth induces a sustained increase in the rate of price change. Milton Friedman’s often quoted statement that inflation is always a monetary phenomenon used the monetarist definition of inflation. It recognized implicitly that non-monetary price level changes are mainly relative price changes.
    A central bank must choose whether to control the price level or the rate of price change. Each has different costs to society. Controlling the sustained rate of price change permits the price level to vary, probably as a random walk. Wealth owners have to accept price variability but can be more confident when planning lifetime asset allocation that inflation will be controlled. Controlling all changes in the rate of price change also incurs a cost. The monetary authority must force other prices to decline if oil (or other) prices rise and permit other prices to rise in the opposite case. Such changes induce allocative changes and temporary changes in output and employment. Experience under the classical gold standard suggests that these costs are not small.
    In practice,