Other things being equal, flotation - in or out - is a bad thing.
Money is an economic unit of account. We use it to calculate profits and losses, enter into contracts, specify debts, and much more. When the yardstick is constantly changing, you are always worried about what a dollar or euro will be worth in the future.
The Fisher effect is the main reason. An economy with modest inflation has higher interest rates compared to one with zero inflation. This means that a low, but positive inflation allows the Fed to reduce rates more in the event of a recession.
In the 1990s, policymakers and economics agreed that a 2% target was a good compromise between competing goals: it was low enough so that people didn't need to worry about the future value money but high enough so that the economy wouldn't often hit the zero-lower bound. This is a situation where cutting interest rates to zero would not be sufficient to restore full employment.
Minimum wage passes inflation test
But they were mistaken. In 1999, an influential US Federal Reserve report estimated that with a 2% inflation target the economy would only be at zero lower bound 5% of the time. In fact, since that paper was published we've been near zero interest rates over a third more of the time.
Many economists believe the target of 2 percent was an error, and that it should have actually been 3 or 4 percent. It's true that economists who are older remember Ronald Reagan's 2nd term when inflation was averaging around 4 percent and no one thought it was a big problem.
Mid-2022, when inflation was running at around 9 percent, it may have appeared distant and abstract to ask if a target of 2 percent was too low. Even then, though, some of us still questioned whether or not the Fed should focus on getting inflation to 2 percent. Why not declare success at say 3 percent?
If you suggested accepting current inflation, and revising the target in accordance with it, I imagine the reaction would be similar to what you might get if someone waved a Pride Flag at a DeSantis event (although there's less chance of getting beaten or shot).
Life is fast. This year's inflation has been a record low, defying predictions of disinflation requiring a large increase in unemployment. Most measures of "underlying" inflation, a vague concept that tries to remove temporary factors such as fluctuations in oil prices or the cost of used cars, which can cause inflation to fluctuate from month to month, are in the neighborhood of 3 percent.
The New York Fed uses some fancy statistical filters to extract what it believes to be the inflation trend underlying the data. It currently places the rate at 2.9%.
The average worker's compensation is increasing by about 4%, which if normal productivity growth continues would translate into inflation of around 3%.
The list goes on.
Why not declare victory on inflation now?
I've met with former and current central bankers. The reaction they give you if suggest that you accept current inflation, and then revise the target in accordance is similar to the reaction I would expect if I waved the Pride flag at DeSantis' rally (although I doubt you'd be beaten or shot). Why?
Main answer is that central banks are concerned about losing credibility if they accept a higher inflation rate, even though economics suggests the conventional target to be too low. This is not a foolish concern. However, monetary credibility matters less than central bankers think for real-world prices.
The ECB is acting to limit inflation. The Irish Government then undermines it
Should policy be locked in to a target which now appears wrong, out of fear it would make policymakers appear weak?
There are three possible outcomes.
The Fed can adopt the (dubiously attributed) position of John Maynard Keynes, 'When facts change, my mind changes' and adopt an openly new inflation target.
- The Fed can adopt a strategy of strategic hypocrisy by insisting its target hasn't been changed, while in reality allowing inflation to be close to 3% for several years. Once it becomes clear that this policy will not allow runaway inflation change the official target.
The Fed can put its money where its mouth (supply) is and do what it takes to bring inflation down to 2%, even if that means a recession.
Option 1 doesn't seem to be on the table. The most likely option is 2. It's possible the Fed may feel compelled to show its toughness and get back to 2%, even though it's probably not good economics.
If this is the Fed's plan, then policymakers must ask themselves: Should American workers be forced to lose their job because of someone else? This article was originally published in
The New York Times
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