The WSJ reports:

Federal Reserve Chairman Ben Bernanke on Wednesday got what he’d been seeking for almost two decades: an inflation target. The Fed said it wants inflation at 2.0% in the long run. The declaration brings it in line with other major central banks, though the Fed remains unique in having an equally important goal of keeping unemployment low, an objective required by Congress. On Wednesday, he got the target enshrined as part of a broad statement of the Fed’s dual goals, in which the central bank specified that it would use a Commerce Department inflation measure called the price index for personal consumption expenditures to track how it’s doing on inflation. The target is meant to assure the public that the Fed won’t stray on inflation—as it did in the 1970s—and will adjust interest rates to ensure inflation doesn’t go too far above or below the goal.

Bad move! And made worse by the fact that the target is a “headline” index. Let´s take a closer look.

The chart below shows the behavior of the PCE index both “headline” and “core”, where the latter excludes volatile prices like food and energy. Over its history the two indices do not diverge, with the “headline” being sometimes above and sometimes below the “core”.

But as gleaned from the next chart, over shorter periods the difference – and direction – of the changes in the two indices can be significant. So targeting the “headline” is not a good idea. For the last three years, for example, while the “core” PCE inflation has remained well below target, the “headline” PCE has travelled “widely”. Over the 15 years depicted in the chart, average “headline” inflation has been 2.06% and average “core” inflation has been 1.81%. In fact, a major reason for the drastic fall in NGDP after mid 2008 was the Fed´s indication that it was “targeting” headline inflation!

In a period of inflation (a rise in ALL prices) both “headline” and “core” move together, although relative price changes (from a rise in oil prices, for example) still take place. But that´s not the situation pertinent to the US since Volcker successfully contained inflation.