A roundup of economic news from around the Web.

Compiled by Phil Izzo

A roundup of economic news from around the Web.

Compiled by Phil Izzo

After being dormant for many months, inflation targeting is back as a serious option at the Federal Reserve.

Ironically, now it’s the risk of outright price declines known as deflation, and not avoiding rapid inflation, that has given new momentum to advocates.

“The argument for inflation targeting now is much easier to make” with the U.S. facing a “massive deflationary shock,” said former Fed governor Frederic Mishkin, who left the Fed four months ago to return to Columbia University.

Mishkin and Fed Chairman Ben Bernanke have championed inflation targets as a way to anchor expectations and provide for better economic outcomes. But momentum for the Fed adopting targets was thwarted in 2007 first by Congressional opposition and then the financial crisis.

Mishkin isn’t alone in still seeing their merits. In the minutes of the Dec. 16 FOMC meeting, released Tuesday, officials discussed as a potential communications tool “a more explicit indication of their views on what longer-run rate of inflation would best promote their goals of maximum employment and price stability.”

“The added clarity in that regard might help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low and support aggregate demand,” according to the minutes.

In other words, a commitment to an inflation target, say annual growth of 1.5% to 2%, would help keep prices from falling outright and prevent the kind of economic chaos that plagued Japan in the 1990s and the U.S. during the Great Depression.

“The key issue here is the management of expectations,” said Mishkin, who co-wrote a book on inflation targeting with Bernanke when both were academics a decade ago. “It’s just as disastrous if inflation expectations get unanchored in the negative direction…this is exactly what happened in Japan.”

Until recently inflation targeting was largely seen the opposite way — as an anti-inflation tool. And Congress, particularly House Financial Services Committee Chairman Barney Frank (D., Mass.), never warmed to the idea, since inflation targets in that context suggested tighter monetary policy and, critics said, an elevation of price stability over full employment as the Fed’s primary objective.

The Fed ultimately scrapped official targets and instead in late 2007 extended their inflation forecast horizon from two to three years and seemed to encourage financial markets to view that third year as a de facto objective.

But it never really stuck, and in their latest set of economic forecasts in late October, officials admitted their 2011 inflation forecast of 1.4% to 1.7% might be a “bit below” their assessment of what’s consistent with price stability and maximum employment.

“The horizon is not long enough” to substitute for a target, Mishkin said.

Of course, by late 2007 the very notion of debating inflation targets seemed like a luxury as the Fed shifted gears to address collapsing housing and credit markets.

But the question remains: do inflation targets, which are used by many other central banks including the European Central Bank (where deflation seems less of a risk), make sense for the Fed?

Vincent Reinhart, who headed the Fed’s monetary affairs division during the early days of the debate in 2006 and 2007, thinks they might. “It’s gone from theory to a useful governing device,” he said.

Reinhart explained that Bernanke faces two problems now that the Fed has effectively shifted from interest rates to quantitative easing as a means to stimulate the economy: communication and governance. The former involves how to explain the purpose of the Fed’s myriad credit programs and resulting expansion of bank reserves. The latter involves the division of responsibilities between the Washington-based Fed Board and the Federal Open Market Committee that includes regional bank presidents.

Inflation targets address both.

When official interest rates are as near zero as they are now, the Fed can’t offset deflationary forces with interest rate cuts to keep inflation-adjusted private borrowing costs down. But an inflation target would convey to the public that officials will use other means, like the Fed’s balance sheet, to prevent prices from falling and also keep inflation expectations from falling too low.

A target might also ease concerns that expansionary fiscal and monetary policy now will sow the seeds of an inflationary outbreak later, and would provide officials a framework with which to eventually unwind their credit programs and rate reductions.

Targets might also head off any friction between the Board of Governors and FOMC. According to Tuesday’s minutes, a “few” FOMC participants wanted the Fed to consider reserve targets to better coordinate between the Board — which sets new lending facilities — and the FOMC, which controls open market operations.

And the Fed can move quickly if it wants. “The Fed could announce (an inflation target) as part of the evolution of the communications strategy,” that Bernanke unveiled in November 2007, Mishkin said.

Officials would have a couple of options. They could simply extend the forecast horizon even further to a fourth or fifth year, in order to make it more clear to the public that their forecast range represents a long-term target. Or they could announce a more explicit FOMC-determined objective.

A challenge for the Fed would be whether to explicitly tie policy, whether via interest rates or quantitative easing, to that target or simply leave it as a forecast that may or may not be achieved.

Mishkin doesn’t regret not sticking around the Fed for this inflation target go-around, even if the odds of success seem higher than we he was a policymaker. “From a personal viewpoint, you can’t get depressed when you have ideas and they don’t get implemented,” Mishkin said. “Ideas take a long time to have an impact,” and “when the right time is there, those ideas can be very powerful.”

And even if it’s for reasons no one would have imagined a few months ago, inflation targeting’s time may be now.

“I don’t see the dynamics [of the inflation targeting debate] being fundamentally different,” Reinhart said, but “there’s a tactical reason to do it right now, and sometimes tactics dominate.” –Brian Blackstone

Min Zeng reports from Washington on the G20 Summit.

Chinese President Hu Jintao urged the international community to guard against erecting protectionist barriers to trade and investment.

In a speech Saturday to the first-ever summit of the Group of 20 industrial and emerging nations, the commander-in-chief of the world’s fourth-largest economy said efforts should be made to promote the Doha Round of trade talks and achieve positive developments soon.

The global trade talks were stalled earlier this year partly due to disagreements between the U.S. and India over farm subsidies. The European Union has also imposed anti-dumping duties on Chinese candles, effective Saturday for six months, after European candle makers complained about losing business to cheaper products from China.

China’s call against trade protectionism has been shared by other leaders, including U.S. President George W. Bush. Concern has been rising that the biggest financial crisis since the Great Depression has weakened global growth, which in turn, may prompt calls for greater barriers against global trade.