Comment on "Taking Intermediation Seriously"

In April 2003, the University of Texas, Austin, the Federal Reserve Bank of Minneapolis, and the Federal Reserve Bank of Cleveland co-sponsored a conference in Austin, Texas, in honor of the contributions and in the memory of Bruce Smith. The program, which included eight presentations over two days, was remarkable in that it consisted almost entirely of papers representing work in which Bruce was engaged at the time of his death.

"Taking Intermediation Seriously," was one of those papers. Originally, Steve Williamson was slated to serve as one of the discussants for the paper at the November 2002 conference represented by this volume. Graciously, Steve agreed to step in and present the paper in Cleveland, as he was to later do in Austin. Although David Andolfatto would be the only discussant at the Cleveland meeting, I had the honor of serving in the discussant's role at the Texas meeting.

I have chosen to exercise my prerogative as editor of this volume, and include my Austin remarks herein. I do so in the hope of highlighting, one more time, the truly remarkable contributions of Bruce's work. To a large extent, this is entirely unnecessary. Those contributions can be easily appreciated by perusing the list of his publications provided in the March 2002 edition of the Minneapolis Fed's Quarterly Review, by noting the astounding number of coauthors with whom he collaborated, or simply inquiring as to his influence on those of us lucky enough to have come into his orbit. But here I wish to emphasize an element of Bruce's efforts that would be too easy to overlook: his abiding interest in the application of economic theory and history to the practice of policymaking.

"Taking Intermediation Seriously," which collects and organizes the issues that had absorbed much of Bruce's interest and energy over the last part of his career, makes the point. In this paper, Bruce points to the future directions that he firmly believed held the most promise for progress in monetary and macroeconomic theory. At the same time, the theory and evidence presented in the paper speak directly to front-burner issues of contemporary monetary policy. I will discuss some of these, in the form of three questions to which "Taking Intermediation Seriously" is directly relevant: What is the "right" rate of inflation? Is deflation problematic? Is our current understanding of the monetary transmission mechanism adequate?

1. The "Right" Rate of Inflation: Motivating Central Bank Behavior

Figure 1 illustrates the target bands for several countries with explicit quantitative inflation objectives. The similarity of the chosen ranges is striking. The target range is currently 1% to 3% annually for both Canada and New Zealand, and 1.0% to 3.0% in Sweden. The targeted inflation rate in the United Kingdom is 2.0%, with a tolerance range of ±1 percentage point, outside of which the Bank's Monetary Policy Committee is obliged to explain its performance.

The European Central Bank (ECB) expresses its objective as less than 2.0% price-level growth (over the "medium term"), and does not directly articulate a lower limit. However, Ottmar Issing, a member of the ECB's Executive Board, has forcefully argued that the Bank's objective "was clearly intended from the start to mean neither prolonged inflation nor prolonged deflation."¹ Issing goes on to argue that "the experience and analyses of recent years have shown that ... inflation and interest rate levels excessively close to zero entail risks of deflation and reduce the scope for monetary policy action."² In the light of these comments, it would be easy to infer that the operational target for the ECB is in the neighborhood of 1% to 2.0%.

There is not much doubt that central bankers in the United States are generally sympathetic to the objective that is expressed in more explicit terms by inflation-targeting central banks. Since the last significant break in the U.S. inflation trend in the early part of the 1990s, annual CPI inflation rates have not been allowed to exceed 3.5%. On the other hand, it is...