"Where the disagreement comes in is which measurement tool you use to effect an automatic rate hike or rate cut. Is it CPI? GNP growth? It is not as simple as it sounds, which is one reason the Fed looks (supposedly) at a myriad of factors to determine if the economy is heating up or cooling down."
Why wouldn't it be the CPI if the Fed's role were limited to maintaining the soundness of the currency? What did Volker use?
People have come to rely on a Greenspan "put" which is inducing moral hazard behavior that eventually will inject greater instability into the system. I realize now that "full employment" is a legislated target, but trying to accomplish that through Fed policy (if that is happening) seems to put us back on the slippery slope. Better to accomplish these other goals through non-Fed policy?
I'm NOT a monetary economist. I'm a historian. But I attended a Liberty Fund seminar with five or six quite brilliant free-market economists discussing this very issue, and none of them could agree on what should be used, if anything, as a "target."
If I were king of the world, I'd have George Gilder be the Fed chairman. He's not an economist, but more of a "futurist," and he thinks that a little (repeat, LITTLE) inflation is actually no inflation because the monetary market is a little slow in adjusting for new inventions, productivity, etc. I tend to agree. People seem to adjust faster to inflation, if it is there, than to deflation. There are psychological elements of economics that are not measured in supply-demand curves---Keynes called them "Animal instincts," and Friedman agreed that they exist. For ex., in the late 1800s, there was humungous deflation, but farm prices appeared to deflate less slowly than all other prices. Well, that didn't sink in to the farmers, who raised "less corn and more hell." The Populist movement was born specifically out of this phenomena, which largely was psychological. And no one denies that psychology can outrace the market at times (See Kindleberger's work in "Manias, Panics," etc.)
My own study of the Panic of 1857, with Charles Calomiris (Journal of Economic History) found that markets reaction to news is based on their ability to transmit and process news---this is more than just "the nightly business news" or the WSJ. For ex., in 1857, the South was not affected at all by the Panic . . . because its banks were largely branch banking systems wherein, even in the 1800s, news about stability, resources, etc., traveled pretty fast between member banks. The NORTH, largely made up of unit banks, did not have that transmission mechanism, and as a result, news about financial flows moved more slowly, allowing panics to set in where they did not in Southern banks. (There were other factors, but this one was important).
Calomiris has MANY articles studying this, with the same conclusion: imperfections in the market vary in their impact, and the more institutional imperfections you eliminate, the more rapidly consumers/depositors react to news. So in that regard, I think Gilder is right in saying that the lubrication of a very small level of inflation overcomes that "lag time" between news of invention/productivity and money growth. I know the Rothbardian goldbugs here will completely disagree.