Saturday, March 05, 2005

Credible money

Econ principles students are taught that markets are a wonderful data source; opportunity cost signals are always being generated and updated. Freely varying prices are a good thing. A changing "price level" is not such a good thing and comes from mismanaged money supplies.

Some students are even taught that defining the price level is hell. "Steering by a faulty compass" in the Feb 26 Economist takes up the question and cites arguements for including asset prices (including house prices) in the proper price index.

There are seemingly good arguments for almost any index. That's the problem. "Given the elusiveness of a perfect price index, central banks should keep using conventional, narrow inflation targets, but be prepared to undershoot them temporarily if house or share prices soar ... and although the calculation would be tricky, central banks migth usefully publish broad price indices ..."

It appears that the only way out of the morass is clarity, credibility and transparency. Adopt an index, publish it and stick to it. Read their lips: no new indices.