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Five Things You Need to Know: Today's Catch Phrase: Inflation Targeting, Object in Mirror Far More Difficult Than Appears, The Great Inflation of the 1970s , Do-Nothing Fed Less Likely?, NBA Shoots for High Scoring All-Star Game


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Today's Catch Phrase: Inflation Targeting

One of the more interesting developments in central banking in the past dozen years or so has been the increasingly widespread adoption of the monetary policy framework known as "inflation targeting."

  • Kudos to Federal Reserve Chairman Ben Bernanke for providing the above lead sentence, which we lifted verbatim from his 2003 speech: "A Perspective on Inflation Targeting."
  • What is inflation targeting exactly?
  • Perhaps the most distinguishing feature of inflation targeting is precisely the notion that the phrase itself conjures up: the public announcement of a quantitative target for inflation.
  • According to Bernanke there are two components to inflation targeting that are useful in distinguishing between a "true" inflation targeting approach and the approach of the Greenspan Fed, which carried certain characteristics of inflation targeting while rejecting the label:
    1. a particular framework for making policy choices
    2. a strategy for communicating the context and rationale of these policy choices to the broader public
  • Familiarize yourself with this concept.
  • As we shall see in Number Two, today's catch phrase should get increasing media play in the coming months.

2. Object in Mirror Far More Difficult Than Appears

The Wall Street Journal's Greg Ip has a piece on inflation targeting in the Wall Street Journal this morning, "Fed Wrestles With Setting Inflation Target." While improving the Fed's communication with the public has been a stated priority of Bernanke's since taking over as Fed chair, the task has proved to be far more difficult than expected.

  • Ok, so we know what inflation targeting is, why should we care about it? Two words: Constrained Discretion.
  • What in the world, you ask, is "Constrained Discretion"? Let's let Chairman Bernanke explain:
    "Constrained discretion attempts to strike a balance between the inflexibility of strict policy rules and the potential lack of discipline and structure inherent in unfettered policymaker discretion. Under constrained discretion, the central bank is free to do its best to stabilize output and employment in the face of short-run disturbances, with the appropriate caution born of our imperfect knowledge of the economy and of the effects of policy (this is the "discretion" part of constrained discretion). However, a crucial proviso is that, in conducting stabilization policy, the central bank must also maintain a strong commitment to keeping inflation--and, hence, public expectations of inflation--firmly under control (the "constrained" part of constrained discretion). Because monetary policy influences inflation with a lag, keeping inflation under control may require the central bank to anticipate future movements in inflation and move preemptively. Hence constrained discretion is an inherently forward-looking policy approach."
  • The part about keeping the public's expectations of inflation firmly under control is what the Fed heads mean when they talk about inflation expectations being "well anchored."
  • Earlier this month, St Louis Fed President Bill Poole told the Financial Times that the Federal Reserve could "sit back" and let the bond market play the role of automatic stabilizer in the economy, even amid concern over the housing slowdown; an attractive situation made possible when inflation expectations were "well anchored."
  • Poole's thoughts echo Bernanke's 2003 speech on inflation targeting: "Well-anchored inflation expectations (by which I mean that the public continues to expect low and stable inflation even if actual inflation temporarily deviates from its expected level) not only make price stability much easier to achieve in the long term but also increase the central bank's ability to stabilize output and employment in the short run," Bernanke wrote.

3. The Great Inflation of the 1970s

So what happens when inflation expectations are not well anchored? According to Bernanke, we get "The Great Inflation of the 1970s."

  • Unemployment and inflation in the 1970s were both high and unstable.
  • However, while conventional wisdom suggests this was an anomaly fueled (literally) by the oil price shocks of the 1970s, Bernanke argues otherwise.
  • "Though increases in oil prices were certainly adverse factors, poor monetary policies in the second half of the 1960s and in the 1970s both facilitated the rise in oil prices themselves and substantially exacerbated their effects on the economy," he says.
  • Well, that paragraph is exciting to read! Seriously, one could follow it up with a full-on Austrian view of monetary policy and Bob's your uncle.
  • Instead, what we get is a reinvention of the wheel according to Bernanke, a better mousetrap that not only catches mice, but breeds them!
  • "Because inflation expectations were no longer anchored, the widely publicized oil price increases were rapidly transmitted into expectations of higher general inflation and, hence, into higher wage demands and other cost pressures. Faced with an unprecedented inflationary surge, the Fed was forced to tighten policy. As it turned out, the Fed's tightening was not enough to contain the inflationary surge but was sufficient to generate a severe recession," Bernanke says.
  • Touche.

4. Do-Nothing Fed Less Likely?

Businessweek is out with an economic editorial suggesting Goldilocks' porridge may heat up, a situation that could begin to try the Fed's patience and lead to additional rate cuts in early 2007.

  • "Earlier this year, rising energy prices had been one of the Fed's inflation concerns, to the extent that companies might be expected to pass along higher fuel costs in the prices of their products. However, costlier energy was also a headwind that helped to slow economic growth. Now, cheaper energy has turned into a tailwind," the article says.
  • We'll not get into the GDP report fueled by those bizarre one-time auto sector gains that will be completely erased in the next report.
  • We'll also not discuss housing.
  • Instead we'll take the opposite side of the "energy as tailwind" debate and let Mr. Bernanke explain why Businessweek is wrong.
  • In reading the 2003 speech, we stumbled across an interesting little nugget buried inside related to, of all things, energy prices as a force relevant to Fed policy expectations.
  • Conventional wisdom, as Businessweek notes, is that the Fed has been worried that rising energy prices may force additional rate hikes.
  • Interesting, because in 2003 Bernanke said increases in oil prices could lead to the opposite!
  • "Because inflation expectations are now more firmly tied down, surges and declines in energy prices do not significantly affect core inflation and thus do not force a policy response to inflation to the extent they did three decades ago. Indeed, rather than leading to a tightening of monetary policy, increases in oil prices today are more likely to promote consideration of increased policy ease--a direct and important benefit of the improved control of inflation."
  • In that case, we'll stick to our expectations of a series of Fed rate cuts in 2007.

5. NBA Shoots for High Scoring All-Star Game

On November 7 Nevada will vote on Question 7, a law that would allow anyone over the age of 21 to possess and use up to one ounce of marijuana in private homes or buildings. Sports Illustrated asks the question foremost on everyone's mind, "Will this affect the NBA All-Star game?"

  • The Nevada referendum to legalize marijuana will have no impact on the 2007 NBA All-Star game in Las Vegas , commissioner David Stern tells
  • But that's not what our special internal Minyanville study concluded.
  • Below are 10 ways the legalization of personal marijuana use and possession in Nevada will impact the NBA All-Star Game.

10 ways Nevada marijuana legalization will impact the 2007 NBA All-Star game:

10. 24-second shot clock feels more like a half hour.
9. Personal fouls replaced by whistles for "harshing the buzz."
8. Pre-game player introduction laser show lasts four hours.
7. Jump ball replaced by jump bong.
6. Coaches no longer advise players in a shooting slump to "pass up the open J."
5. All 30-second timeouts now come with extra cheese.
4. Even the big men can "light it up" from outside.
3. "Choking" in the final seconds no longer stigmatized.
2. Two words: High Five
1. The game doesn't end until everybody "scores."

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