Too much inflation? Just increase the inflation target – OpEd – Eurasia Review
By Ryan McMaken *
At the end of August, Fed Chairman Jerome Powell suggested the Federal Reserve would start cutting before the end of the year, admitting that price inflation exceeded the 2% target. Nonetheless, the Fed took no immediate action the following month. This week, Powell again suggested that a cone would start soon, saying it would start early enough for the process to “come to a close.”[e] around the middle of next year ”, and could perhaps start in November. This, of course, was highly conditional, with Powell noting that this decrease would only occur if “the economic recovery stays on track.”
Some have interpreted this as a hawkish turn for Powell, but again, we shouldn’t expect any immediate action on this. Dull economic growth remains a concern, and Powell’s label of “recovery” staying on track will be key. Last week, Goldman lowered the forecast for economic growth in the United States, and the Beige Book – which still casts a rosy glow on economic growth – also reduced its description of the economy in July and August to “moderate.” . Meanwhile, the Bank of England today signaled a worsening global situation with its own downgrade in growth expectations. In other words, if the economy does not improve enough, according to the Fed, it can simply abandon its phase-out plans.
A weak recovery
We saw similar rhetorical games in the decade after the Great Recession. Growth was remarkably slow at this time, even with massive monetary stimulus. Despite this, the Fed has repeatedly spoken of an “improving economy” and repeatedly hinted at a decrease. But it wasn’t until 2016 that the Fed dared to let the target interest rate rise slightly. This was done in large part out of fears that the Fed would have no wiggle room in the event of a new crisis. Price inflation, after all, has remained low in official measures.
But in 2017 and 2018, when CPI inflation started to surpass 2%, the Fed was expected to finally start declining significantly to keep inflation close to the target. by 2%. This alarmed some inflation doves who feared – and rightly so – that any restriction of the Fed’s easy monetary policies would end the very fragile and lackluster recovery then underway. They wanted to keep asset price inflation going – to reap the benefits of the so-called “wealth effect”. These fears were partially confirmed when, despite the timidity of the Fed’s post-2018 reduction efforts, the 2019 repo crisis suggested that problems were indeed brewing.
It is not known how this would have happened in the absence of the covid panic. In any case, the efforts to control monetary inflation evaporated with the covid crisis and the target interest rate was quickly reduced to 0.25%. Purchases of additional assets have picked up at breakneck speed, with the Fed’s portfolio soon surpassing $ 8 trillion.
Push inflation targets up
In addition, the covid crisis has given the doves the opportunity to push for a more “flexible” inflation target. In August 2020, as central bankers searched for new ways to justify continued stimulus measures, the Fed adopted a new policy in which it would pursue an “average” inflation target of 2%. In other words, the Fed could now pursue a price inflation target. above 2% for certain periods, provided everything is on average at 2% overtime.
But even that was not enough for supporters of ever higher price inflation. We are now seeing calls to end and increase the 2% target.
The catalyst is the fact that price inflation has been on the rise. The Fed now admits that inflation has risen again, with expectations of an inflation rate above 4 percent by the end of the year. (This is consumer price index inflation, of course, not the much larger asset price inflation, which the Fed carefully ignores.)
How inflation fears place political limits on easy money policies
The need to raise the target rate is political. Presumably, the longer inflation persists above the target rate, the more pressure the Fed will feel to bring inflation down through some kind of reduction. After all, adopting a 2% target implies that 2% is the “correct” rate of inflation. Anything higher than that is probably “too much”. With the Fed having adopted the 2% target since the 1990s, the Fed’s credibility is at stake if the Fed simply ignores the target.
All of these inflation worries have become too big for those who want to see the Fed come out of what they see as a straitjacket imposed by the 2% target. For example, write to the the Wall Street newspaper Earlier this month, Greg Ip noted that Powell appears to be banking on the inflation rate returning to 2%. But what if it doesn’t? Ip says if inflation stays above targets, the Fed should just raise targets. He writes:
A strategy [Powell]—Or its successor — should consider simply raising the target in this event.
And why pursue higher inflation? Ip takes the popular view of the “mythical trade-off between increased employment and inflation,” as Brendan Brown describes it. For Ip, higher inflation is the way to ensure employment-fueled expansion, and he writes:
Why would higher inflation be a good thing? Economic theory says that stable and slightly higher inflation should mean fewer and less severe recessions, and less need for exotic tools such as central bank bond purchases, which can inflate bubbles. ‘assets. More concretely, if inflation gets close to 3% from 2% next year, raising the target would relieve the Fed of raising interest rates to lower inflation, thereby destroying jobs.
According to Ip, the too low 2% target puts the Fed in an intolerable impasse. The Fed needs more room to breathe. Rather than feeling the pressure of a cut just because price inflation has passed the 2% target, Ip wants to make sure the Fed can keep raising until price inflation goes above. 3% or even 4%. And who knows? After that, maybe “economic theory” will tell us that 5% inflation is an even better target. Granted, that wouldn’t be a less arbitrary number than 4 or 2 percent.
But it’s a safe bet that if the accepted inflation target was 4%, we would hear next to nothing at this time of reduction, normalization or any other effort to reduce price inflation. The Fed would then be freer to keep the easy money tap on longer without having to hear complaints that the Fed has “lost control” over price inflation. It would be great for stock prices and real estate prices. Ordinary people, on the other hand, might fare worse.
* About the Author: Ryan McMaken is Editor-in-Chief at the Mises Institute. Send him your article submissions for the Betting Thread and Power and market, but read the article guidelines first.
Source: This article was published by the MISES Institute