An Elegant But Dangerous Idea; The Federal Reserve has waged a noble battle against inflation without any targeting rule.

Byline: Stephen S. Roach (Roach is the chief economist at Morgan Stanley.)

We draw a false sense of comfort by thinking of economics as science. We risk an equally false sense of security by relying on central bankers who claim they can guide economies with mechanistic policy rules. Inflation targeting is one of those rules. It's the rage in central-banking circles these days. In theory, it is an elegant proposition. It works something like this: First, pick a metric--the consumer price index, the broader GDP price deflator or any other price gauge. Second, set a numerical goal for this metric--a zero inflation rate, a range of 1 to 2 percent, or higher. Third, communicate clearly the possibility of hitting the target--whether inflation is accelerating, stable or decelerating. Fourth, set the policy instrument--the overnight bank lending rate--with an aim toward bringing inflation into alignment with the target. Presto--the economy is cured of any and all ailments.

If it were only that easy. The risk is that central banks may delude themselves into thinking that the successes of the last 25 years on the inflation front are traceable to a rules-based monetary policy. The European Central Bank, for instance, is the world's leading inflation targeter. America's Federal Reserve has no such explicit mandate. Yet the Fed now wants to turn itself into the ECB. Newly appointed chairman Ben Bernanke was one of academia's leading inflation targeters. Frederic Mishkin, a new Fed governor, is another luminary of this sect. They could well be a formidable team in pushing the Fed to adopt a price rule.

This could be a big mistake. Keep in mind that the Federal Reserve has waged a noble battle against inflation without any such rule. It took the wisdom and political independence of former Fed chairman Paul Volcker to break the back of inflation. Alan Greenspan preserved these hard-won gains. Neither central banker operated with a mechanistic rule--they relied on experience, judgment and discretion to get the job done.

Ironically, Bernanke's performance since he took over as Fed chairman in February underscores the pitfalls of inflation targeting. His policy moves have been fine--three additional monetary tightenings following 14 moves by his illustrious predecessor. But on the communications front, he has committed a number of flip-flops that have left financial markets in confusion. If this record is indicative of Bernanke's communication skills, a shift to inflation ...