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Flying Blind: The Federal Reserve's Experiment with Unobservables

Listed author(s):
  • Dimitri B. Papadimitriou
  • L. Randall Wray

During the last fifteen years the Fed has experimented with a variety of monetary targets, including reserve aggregates (borrowed and nonborrowed); monetary aggregates as measured by M1, M2, and even M3; prices, as measured by P-Star, price indexes, gold prices, and expected inflation; and a variety of interest rates, including real "equilibrium" interest rates; choosing a new target variable, therefore, was not a novel event. However, although some members of the Fed proclaim their newest targets to be linked to actual inflation, the most recent switch is disconcerting to many Fed observers because there is little or no theoretical or empirical evidence to support the use of these variables as targets. Moreover, experience with a variety of targets has cast doubt on the likelihood that a single variable can be found to be closely and reliably linked to future inflation. It is even less likely that such a variable, should it be found, would somehow be under the control and manipulation of the Federal Reserve. In their paper "Flying Blind: The Federal Reserve's Experiment with Unobservables," Dimitri B. Papadimitriou and L. Randall Wray contend not only that there is no reason to suppose that the Fed will discover a target variable whose control will yield stable prices, but that the Fed simply does not know how to achieve stable prices. They argue that economists lack sufficient information to calculate the costs of achieving stable prices in terms of unemployment and lost output. Therefore, the Federal Reserve ought to take a less active role in the economy.
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Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_124.

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Date of creation: Sep 1994
Handle: RePEc:lev:wrkpap:wp_124
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  1. Michael F. Bryan & Stephen G. Cecchetti, 1994. "Measuring Core Inflation," NBER Chapters,in: Monetary Policy, pages 195-219 National Bureau of Economic Research, Inc.
  2. Anatol Balbach, 1981. "How controllable is money growth," Review, Federal Reserve Bank of St. Louis, issue Apr, pages 3-12.
  3. John B. Carlson, 1993. "Assessing real interest rates," Economic Commentary, Federal Reserve Bank of Cleveland, issue Aug.
  4. Karl Brunner, 1968. "The role of money and monetary policy," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 8-24.
  5. Joseph A. Ritter, 1993. "The FOMC in 1992: a monetary conundrum," Review, Federal Reserve Bank of St. Louis, issue May, pages 31-49.
  6. W. Lee Hoskins, 1991. "Defending zero inflation: all for naught," Economic Commentary, Federal Reserve Bank of Cleveland, issue Apr.
  7. John B. Carlson, 1994. "Assessing progress toward price stability: looking forward and looking backward," Economic Commentary, Federal Reserve Bank of Cleveland, issue May.
  8. W. Lee Hoskins, 1991. "Defending zero inflation: all for naught," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 16-20.
  9. Jerry L. Jordan, 1993. "Credibility begins with a clear commitment to price stability," Economic Commentary, Federal Reserve Bank of Cleveland, issue Oct.
  10. Daniel L. Thornton, 1988. "The borrowed-reserves operating procedures: theory and evidence," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 30-54.
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