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With the Federal Reserve having trouble pushing inflation down to 2%, where it already chews away at Americans’ savings like a stealth tax on their wealth, some economists want to move the goalposts by giving the Fed a target of 4% inflation instead. Justin Lahart reports in The Wall Street Journal:
Inflation is still higher than the 2% the Federal Reserve is aiming for, and maybe that is OK. That is, if we could just put aside the fact that we hate inflation so much.
Fed policymakers are poised on Wednesday to leave their benchmark federal-funds rate steady at the highest level in more than two decades, and inflation is the biggest reason. Their preferred measure of consumer prices, from the Commerce Department, was up 2.7% from a year earlier in April. That marks an improvement from April 2023, when it was up 4.4%, but still doesn’t show the kind of progress investors were hoping for at the beginning of the year, when they were betting the Fed would be cutting by now.
Before the pandemic, high inflation would have struck a lot of economists as a high-class problem.
Low inflation, extremely low interest rates and the tepid economic recovery following the 2008 financial crisis had led some prominent economists to push for a much higher target inflation rate than 2%.
The problem, as they saw it, was that the real natural interest rate—the inflation-adjusted rate that was just right to keep the economy running smoothly—had fallen. It put the economy in a perilous state: If a recession hit, the Fed didn’t have much scope for cutting rates before hitting zero. This “zero lower bound” problem meant that the Fed would need to turn to less potent ways to stimulate the economy, such as asset purchases. As a result, economic recovery would be halting, with millions of workers again cast into long periods of joblessness.
But a higher inflation rate would, over time, allow the Fed to set interest rates higher. Then, when the economy ran into trouble, the central bank would have more scope to cut rates before hitting zero. Olivier Blanchard, then the chief economist of the International Monetary Fund, in 2010 suggested a 4% target would do the trick. Another advocate of a higher target, Johns Hopkins economist Laurence Ball also thought 4% was the right number.
Before the pandemic, Jón Steinsson, an economist at the University of California, Berkeley, was sympathetic to the idea of setting the inflation target higher. Now he isn’t, and the reason is simple: He has come to realize that Americans detest what economists like him thought of as relatively modest amounts of inflation.
Consumer sentiment remains extremely low, despite low levels of unemployment and continued wage growth, and the inflation experience of the past few years seems to be a major reason. Even as the Fed’s favored inflation measure has moderated from the 7.1% hit in June 2022, prices are far higher than they were before the pandemic. And while economic models might suggest that people really shouldn’t hate inflation as much as they do, that isn’t a good reason to discount their feelings.
Action Line: Calling for four percent inflation would be a disaster, mainly because Main Street America understands that it would end up being much higher. What we desperately need is a return to some sort of gold standard where your dollar value doesn’t bounce around like a rubber ball. Click here to subscribe to my free monthly Survive & Thrive letter.
E.J. Smith - Your Survival Guy
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