What Does the Financial Crisis Mean for Inflation Targeting?

The big recent argument in monetary policy is between those who think
central banks should just target core inflation -- incluidng Greenspan,
Bernanke and very much the Bank of Canada -- and those who think it
should also worry about asset bubbles -- in other words, take away the
punch bowl just when the party is getting started.

One appeal of inflation targeting is that it seems to address the
problem of legitimacy central banks face. They make decisions with
enormous impacts on the economy, but they are purposively insulated from
democratic accountability. If they can say that they have little
discretion, and simply follow a simple rule of keeping inflation steady,
then they can more easily justify themselves than if they admit that
they have massive discretion. And a mandate to deal with asset bubbles
necessarily involves discretion, since no one can precisely say when
they occur and because the central bank would have to do more than one
thing at a time, necessitating tradeoffs.

The difficulty with the simple rule, though, is that core inflation is
not as big a problem as asset bubbles. So solving a minor problem at the
risk of exacerbating a bigger problem looks like a bad idea.

But what we will be left with is a super-empoweered central bank without
a clear rule to guide it. In other words, what we will be left with is
less democracy and more technocracy.