Despite the low inflation of recent years, some observers have wondered whether rapid gains in U.S. asset prices foreshadow rising inflationary pressures. Would U.S. monetary policy be improved if Federal Reserve policymakers reacted systematically to changes in the prices of widely held assets such as stocks and houses? Some monetary experts believe so. In particular, Charles Goodhart, a former member of the Bank of England's Monetary Policy Committee, argues that central banks should consider using housing prices, and perhaps, but to a much lesser extent, stock market prices to guide their policy decisions.> Goodhart has recommended that central banks replace conventional inflation measures--such as the CPI or PCE price index--with a broader measure that includes housing and stock market prices (weighted appropriately). This measure has the potential to improve macroeconomic performance if asset prices reliably predict future consumer price inflation. Other experts, however, question the ability of housing and stock prices to predict future inflation. And, even if asset prices help predict inflation, a central bank's reactions to such volatile asset prices might not necessarily improve macroeconomic performance.> Filardo evaluates the net benefits to the U.S. economy of adopting Goodhart's recommendation. First he reviews the historical and theoretical motivation underlying the recommendation and discusses its monetary policy implications. Next he examines empirically whether U.S. housing and stock market prices help predict future consumer price inflation. Based on these findings, he simulates a macroeconomic model to explore the net benefits of a policy that responds to these asset prices. He concludes that adopting Goodhart's recommendation would not improve U.S. economic performance.
