Robert Lucas in Today's WSJ on Inflation Targeting
In the past 50 years, there have been two macroeconomic policy changes in the United States that have really mattered. One of these was the supply-side reduction in marginal tax rates, initiated after Ronald Reagan was elected president in 1980 and continued and extended during the current administration. The other was the advent of "inflation targeting," which is the term I prefer for a monetary policy focused on inflation-control to the exclusion of other objectives. As a result of these changes, steady GDP growth, low unemployment rates and low inflation rates -- once thought to be an impossible combination -- have been a reality in the U.S. for more than 20 years.
I am skeptical about the argument that the subprime mortgage problem will contaminate the whole mortgage market, that housing construction will come to a halt, and that the economy will slip into a recession. Every step in this chain is questionable and none has been quantified. If we have learned anything from the past 20 years it is that there is a lot of stability built into the real economy.
To me, inflation targeting at its best is an application of Milton Friedman's maxim that "inflation is always and everywhere a monetary phenomenon," and its corollary that monetary policy should concentrate on the one thing it can do well -- control inflation. It can be hard to keep this in mind in financially chaotic times, but I think it is worth a try.