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Submitted by Dan Biller on
Inflation Targeting, The speed of transmission and asset prices: The paper underscore the "demise" of the Taylor Rule due to asset prices. Maybe the problem is in fact broader that this. Inflation calculation as measured by CPI has recently come under scrutiny, and even GDP has measuring issues. If we turn to developing countries, using inflation targeting may further augment errors - some large countries for example use Wholesale Price Index (WPI) to measure inflation and others' impressive GDP growth have been questioned in several fora to be grossly over estimated. If we add the speed of transmission in some markets, which in fact is a critique of the Taylor rule given that policy makers face real-time information, one can't help but rethink the use of inflationary targeting. On the other hand, the alternative is not clear and the only potential policy advice that one can think is for Central Bankers to add a significant cushion their decisions being more conservative at times of positive growth and more loose at times of negative growth. The question remains how to determine this amount, which can also be assisted by reviewing the decision more often as information is available. In a sense, one could learn from the precautionary principle that is quite popular in climate change discussions. Yet, if a Central Bank has problems due to real-time information, imagine a Financial Regulator!: The paper implicitly argues that Central Banks are better equipped to regulate at least some asset markets (see additional comment below) via monetary policy instruments or similar instruments than financial regulators. Intuitively, this makes sense at least in part because of the transmission mechanism problem. Working via markets, monetary policy may impact asset prices faster than regulatory instruments. While this may still be slow, and the speed may be a point of contention (e.g. the current asset bubble bursted the moment the FED increased interest rates), it should be certainly faster than regulatory measures. Differentiating among asset markets as not all are equal may also be needed, but this caveat is missing from the note. When the note discusses asset markets, it seems in fact to be discussing more the real estate related asset market. Derivative Market Safeguards: If real estate asset markets metamorphosed as mortgage backed securities sold as a derivative market (e.g. oil futures), mark to market would be in place and margin calls would take place. At the day's end, regulators should know who have the "rope around the neck" and could act much faster to avoid collapse. Yet, somehow this was never in the cards, and one of the main issues is that no one knows the size of the damage. Mark to market is a lesson that even Central Banks could learn if they move to regulate asset markets of mortgage backed securities. Yet, the need for Central Bank intervention in other asset markets such as oil, commodities and even stocks is less clear.