Following on from the earlier post on price-level targeting and inflation targeting if you look a the current policy of the US Fed we see that the success of QE2 (second round of quantitative easing) depends on how you view the data. Fed Chairman Ben Bernanke has made it clear that he considers an inflation rate of approximately 2% to be consistent with the directive from Congress. However, was the intention of QE2 to bring the price level up to the original path of 2% or to rebase the objective and aim for 2% from QE2 onwards? The latest data, shown in the chart below, suggests that there is a policy of price-level targeting with the inflation rate (red line) climbing above the rebased 2% target (dotted green line).
Below is an excerpt from economonitor.com
The chart starts in January 2009, just at the point when inflation began to drop below 2 percent. Over the next year and a half, the actual price level fell farther and farther below the original 2 percent path. If QE2 had been intended as classic inflation targeting, its objective would have been get onto and stay on a 2 percent path rebased in November 2010. As the price level rose above the rebased target, as it began to do already in January 2011, the Fed would have had to ease off its expansionary policy in order to prevent excess inflation. Instead, the Fed continued with the full planned program of QE2, even as inflation rose to 3 percent and above during the late winter and spring of 2011.
Does this mean we will see a happy ending to the QE2 saga? It is too soon to be sure. It looks like the Fed has administered a dose of expansionary policy large enough to satisfy Dr. Evans, but we don’t know yet if the patient will make a full recovery. We still need to wait a while to see how those annoying real indicators respond to the medicine. If GDP growth is back on track a year from now, with unemployment starting to fall and the housing market out of the intensive care unit, then we can celebrate the triumph of price-level targeting.