Once, while a good friend was visiting me on a particularly cold winter's night, the temperature in the poorly uninsulated living room of my old Victorian house dropped to a distinctly chilly 62 degrees. "Can't you make it any warmer?" she asked? "I'm afraid I can't," I said; "the thermostat's already on 68." "Try setting it at 80," she replied.
I didn't indulge her (well, not that way). But I wonder whether those economists who have been calling for a higher inflation target would have.
I challenged George about the analogy by e-mail, writing:
I get the futility, obviously, about why setting the thermostat higher won't work. But what is the analog? Is it that the Fed has set an inflation target above the current inflation rate and so it doesn't make sense to set it even higher? If so, I get that. But is it as clear in the Fed case as in the home heating case that the Fed is actually setting a higher target rate? Couldn't it be that the Fed says it is, but it isn't? So, to go back to your home heating case, the analog would be you telling your guest that you already set it at 68, whereas you actually set it at the current 62.
George assured me, as did other monetary economists, that the Fed really means it when it says its inflation target is 2%.
Specifically, here's what Jeff Hummel wrote in response to my challenge to George:
You raised a good question: if the Fed really wants 2 percent inflation, why aren't they achieving it? After all, central banks traditionally could deliver any long-run rate of inflation they wanted as long as they had the will to do so. But I think that George and Jerry are right; 2 percent is their actual goal. So what explains the failure of technique? My answer would be Fed targeting of interest rates, yet again. As long as interest rates are really low (for reasons other than monetary policy), they think their policy is very loose and just not yet working. Couple that with the fact that paying interest on reserves and other policies designed to allocate credit are offsetting their expansion of the monetary base.
So, yes, George Selgin's thermostat analogy holds but it needs to be revised, and in a way that loses a lot of the analogy's power. It would be as if his guest asked him to set the thermostat higher than the 68 he thought he had set, but it turned out that he thought wrong. George had never set it. Instead, he assigned the task to someone else who assured him that it was set at 68 when actually the person kept it at 62. [The analog to this person's word is using interest rates as an indicator of tightness or looseness. The person he tasked lied. Interest rates "lie" as an indicator of tightness or looseness.]