Richard Timberlake and Thomas Humphrey have a very informative article at Cato that presents a new standard for the Federal Reserve of a 0% inflation rate. From a purely academic stance, I would say that an inflation rate of 0% is still too much. In a true capitalist system, prices should fall as the economy becomes more efficient. Nevertheless, this would be a hell of a lot better than what we have now:

Since at least 1980, “price level stability,” as a major objective of Fed policy, has been prominent in the FOMC’s Policy Directive to the Fed Bank of New York. Indeed, in 1988 with Chairman Greenspan’s arrival on the scene, what had been phrased “reasonable price level stability” became just plain “price level stability,” with no “reasonable” qualification.

The government’s Consumer Price Index (CPI) shows price level increases over this period. For 1980, the CPI was 86 (1982-84=100). By 2007, it was 211, which means that prices were almost 2 1/2 times in 2007 what they were in 1980. Therefore, the value of the dollar, being the reciprocal of “all prices,” declined from 100 to 41. Is this result–a 59 percent reduction in the value of the money unit–“long-run price stability”? Is the value of the dollar “stabilized” when it loses three-fifths of its value every 20 to 25 years? Clearly not.

They give 5 reasons why the goal should be 0% and then end with this:

A monetary standard has been missing in the United States since the formal abandonment of gold in 1971. Under the working gold standard throughout the nineteenth century and up to World War I, the world-gold-value of goods determined all money prices. World prices were astonishingly stable, even though all relative prices could fluctuate in accordance with real demands and real supplies. After the United States went off the gold standard, however, the FOMC, buffeted by the political forces in Washington, has determined monetary policy. The long-run result has been ninety-five years of various rates of inflation, and a dollar that has lost ninety percent of its purchasing power since the Fed came into existence in 1913.

Congress has the power and the responsibility to specify a Stable Price Level Standard for the U.S. monetary system. To implement this new standard, either the FOMC would apply it operationally, or Congress would formally charge the Fed to deliver a zero rate of inflation as measured by a comprehensive price index from quarter to quarter.

The only problem I see is that it is impossible to construct a true price index. Asset prices have to be part of the equation (think about our serial bubbles) and the price index can be manipulated. Gold is the only answer.

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