Reply to Garrison and White

Abstract

Gairison and White (henceforth G-W) have written an interesting critique of my 1995 paper on CPI futures. They have questioned the feasibility of using short-term CPI futures as a target of monetarzr policy, and have also criticized my auxiliary proposal for using long-term CPI futures as a way of overcoming the timeinconsistency problem. G-W have found some significant flaws in my proposal, but I don't believe these problems to be unsolvable. Before discussing their most important criticism, I will briefly respond to G-W's critique of my solution to the time-inconsistency problem. In my proposal, I argued that if speculators expected inflation, then they would buy long-term CPI futures from the government. In that case, the government would be taking a short position and would thus have less incentive to adopt an inflationary policy. Assuming that speculators would continue to buy CPI futures so long as the expected inflation rate was significantly higher than zero, then equilibrium would occur when the potential losses to the government from CPI futures were just large enough to deter the central bank from inflating the money supply. G-W suggest that the government could simply print money to pay off the successful speculators, and that there is no reason why a central bank would feel constrained by these potential losses. They argue that:

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