Alexander Salter argues that “there’s no good reason to raise the inflation target,” and while he makes some valid points, his analysis goes awry because it is based on the faulty quantity theory of money. He says that the proponents of a higher inflation target erroneously believe that it would “give the Fed more wiggle room to ease policy, should recessionary pressures emerge.” Salter says that the Fed can still stimulate nominal spending even when interest rates hit the zero lower bound, a boundary that the Fed is more likely to bump into with a lower inflation target.

Salter correctly notes that inflation hinders economic growth, which means that, from the Fed’s perspective, there are tradeoffs in their monetary policy choices, including their choice in an inflation target. A higher inflation target means hampered long-run growth, even if we accept the view of the higher target proponents that it gives the Fed more room to respond to short-run shocks. So, not only is a higher target unnecessary, but it comes at a cost.

What should the Fed do?

Salter outlines what the Fed should do:

The Fed’s job is to nudge dollar-denominated variables in the right direction. Monetary policy is much more like recalibrating the economy’s barometer than flooring the economy’s gas pedal.

Of course, expansionary policy (printing money to purchase securities) can help fight recessions. […] It’s proper to grow the money supply in response to a sudden and unexpected increase in money demand.

This is a laughably rosy view of the Fed’s capabilities, and it contradicts other accurate claims that Salter makes: “Markets are good at creating wealth when prices correctly signal relative resource scarcities” and “Tinkering with money introduces noise in the pricing process.”

He seems to understand that messing around with money distorts market prices, and yet he suggests that the Fed can “recalibrate the economy’s barometer,” “fight recessions,” and equilibrate the supply of and demand for money. But how can the Fed “nudge dollar-denominated variables” without “introducing noise in the pricing process”? Can the Fed “fight recessions,” in which entrepreneurs must revise their plans in light of the realization of malinvested capital, by “recalibrating the economy’s barometer”? Can the Fed establish monetary equilibrium by “tinkering with money”?

The answer to these conundrums is found in a proper understanding of the non-neutrality of money. As Ludwig von Mises explained, “the first question that catallactics must raise with regard to changes in the total quantity of money available in the market system is how such changes affect the various individuals’ conduct.” Individuals demand money. Individuals trade with one another at market prices. Individual entrepreneurs make production plans and employ resources accordingly.

There’s no such thing as the price level

Monetary policy can never “recalibrate the economy’s barometer” because new money enters the economy at a particular point. Certain individuals receive higher incomes first, which allows them to increase their demands for goods they want to buy. The prices of those goods rise, and the sellers of those goods now have higher incomes than they would have had.

We get the image of a ripple effect, in which the new money ripples out from its origin, resulting in higher incomes, increased demands for some goods, and higher prices in its wake. On the outskirts, we have individuals whose incomes rise last, or not at all, but must pay the higher prices that were bid up by those earlier in the step-by-step process. The result is a Misesian “price revolution” and a permanent alteration to the distribution of incomes and wealth.

There is no barometer here – there’s no way to capture this process with a single measurement, and there’s certainly no such thing as a “price level” that rises uniformly for an entire population.

Booms and busts

The unevenness of monetary expansion explains the source of business cycles. When new money enters the economy through credit markets, it starts an artificial boom that inevitably leads to a painful bust. But to see why the Fed shouldn’t “fight recessions” with expansionary monetary policy, we must understand the fundamental entrepreneurial errors made during the boom that need correction in the bust.

Credit expansion makes big, long-term production projects look profitable due to artificially low interest rates. The structure of production is rearranged as both new and existing capital goods are deployed in new lines of production. The boom also features overconsumption due to the lower interest rates and increased nominal incomes.

Once the scarcity of capital rears its ugly head, usually with a spike in interest rates, entrepreneurs abandon their projects, liquidate capital, and disemploy workers. Entrepreneurs must reevaluate their plans and find profitable projects that align with real savings.

The recession is not just an unexpected decrease in nominal spending – it’s a correction of specific errors made in the past. Expansionary monetary policy designed to stimulate spending only hampers (or even reverses) this healthy process and sets the stage for another unsustainable boom.

Monetary equilibrium

A micro-level understanding of monetary equilibrium also negates Salter’s conclusion that “It’s proper to grow the money supply in response to a sudden and unexpected increase in money demand.” In fact, monetary equilibrium is established in the same step-by-step market process whereby market participants act and exchange according to their preferences for goods and money.

Consider one exchange: Frank buys one book from Joe for $15. Frank values the book more than $15, and Joe presently values the $15 over the book. The exchange “clears the market” because the quantity of books demanded by Frank equals the quantity of books supplied by Joe. But the market clears for money as well: the quantity of money demanded by Joe equals the quantity of money supplied by Frank. Any books retained by Joe is a part of his reservation demand for books and the money retained by Frank is his reservation demand for money. There’s no room for the blunt tools of monetary policy to facilitate this process.


The only monetary institution that can accomplish Salter’s goals is sound money. A market-selected commodity money enables economic growth without any inflation target to speak of. Markets are made up of individuals with their own values and plans – there is no overall plan or macroeconomic target. Imposing such a thing only distorts the market process and hinders economic growth.

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By Mises