{"id":180473,"date":"2023-08-24T06:58:59","date_gmt":"2023-08-24T06:58:59","guid":{"rendered":"https:\/\/precoinnews.com\/?p=180473"},"modified":"2023-08-24T06:58:59","modified_gmt":"2023-08-24T06:58:59","slug":"why-not-change-the-inflation-target-and-call-it-victory","status":"publish","type":"post","link":"https:\/\/precoinnews.com\/economy\/why-not-change-the-inflation-target-and-call-it-victory\/","title":{"rendered":"Why not change the inflation target, and call it victory?"},"content":{"rendered":"

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Add articles to your saved list and come back to them any time.<\/p>\n

Flation \u2014 whether in- or de- \u2014 is, other things being equal, a bad thing.<\/p>\n

Money is the economy\u2019s unit of account, the yardstick we use to calculate profit and loss, make contracts, specify debts and more. It\u2019s problematic when that yardstick keeps changing length, when you have to worry about how much stuff a dollar will buy in the future.<\/p>\n

<\/p>\n

Federal Reserve boss Jerome Powell : It\u2019s possible that the US central bank will feel obliged to prove its toughness by getting inflation back to 2 per cent.<\/span>Credit: <\/span>Reuters<\/cite><\/p>\n

Nonetheless, the Federal Reserve, like all major central banks these days, doesn\u2019t aim for complete price stability, or in other words, for 0 per cent inflation. Why? Mainly because an economy with modest inflation will normally have somewhat higher interest rates than one with zero inflation \u2014 a phenomenon known as the Fisher effect. And this means that low but positive inflation gives the Fed more room to cut rates in the face of a recession.<\/p>\n

Back in the 1990s, policymakers and economists converged on the view that a 2 per cent target achieved more or less the right trade-off between these competing objectives: low enough that people wouldn\u2019t have to think too much about the future value of money, high enough that the economy would rarely hit the zero lower bound, that is, a situation in which cutting interest rates even all the way to zero wouldn\u2019t be enough to restore full employment.<\/p>\n

But they were wrong. In 1999, an influential Fed paper estimated that with a 2 per cent inflation target, the economy would be at the zero lower bound only 5 per cent of the time. Since that paper was released, we have in fact been at near-zero interest rates more than a third of the time.<\/p>\n

So if the 2 per cent target was probably a mistake, why not just declare victory over inflation today?<\/p>\n

As a result, many economists now believe that the 2 per cent target was a mistake, that it should have been 3 per cent or even 4 per cent. For what it\u2019s worth, economists of a certain age remember Ronald Reagan\u2019s second term, when inflation averaged around 4 per cent, and few thought of it as a terrible problem.<\/p>\n

[Australia\u2019s Reserve Bank has a 2 per cent to 3 per cent target range.]<\/p>\n

In mid-2022, with inflation running around 9 per cent, the question of whether a 2 per cent target was too low may have seemed remote and abstract. Even then, however, some of us questioned whether the Fed should be fixated on getting inflation all the way back to 2 per cent. Why not stop at, say, 3 per cent and declare the job done?<\/p>\n

And life, it turns out, comes at you fast. Inflation in the world\u2019s largest economy has plunged this year \u2014 defying predictions that disinflation would require a big rise in unemployment. Most measures of \u201cunderlying\u201d inflation \u2014 a somewhat ill-defined concept, but basically an attempt to abstract from temporary factors like fluctuations in the price of oil or used cars that can cause month-to-month inflation to bounce around \u2014 are running in the vicinity of, yes, 3 per cent. The New York Fed, using some fancy statistical filtering to extract what is supposed to be the underlying inflation trend, currently puts the rate at 2.9 per cent.<\/p>\n

Worker compensation in the US appears to be rising at around 4 per cent, which given normal productivity growth would mean inflation of around 3 per cent.<\/p>\n

And so on down the line.<\/p>\n

So if the 2 per cent target was probably a mistake, and if we could do it over again, we\u2019d probably go for 3 per cent, why not just declare victory over inflation today?<\/p>\n

OK, I\u2019ve been in meetings with current and former central bankers, and the reaction you get if you suggest accepting current inflation and revising the target accordingly is more or less the reaction I imagine you\u2019d get if you waved a rainbow flag at a DeSantis rally (although you\u2019re less likely to get beaten up or shot). Why?<\/p>\n

The main answer seems to be concerns that accepting somewhat higher inflation \u2014 even if the economics suggest that the conventional target is too low \u2014 would damage central banks\u2019 credibility. That\u2019s not an entirely foolish concern, although monetary credibility probably matters much less for real-world inflation than central bankers tend to imagine.<\/p>\n

On the other hand, should policy be permanently locked into a target that now looks wrong out of fear that changing it will make policymakers look weak?<\/p>\n

At this point I see three ways this could go:<\/p>\n

\u2014 The Fed could adopt the position attributed (dubiously) to John Maynard Keynes \u2014 \u201cWhen the facts change, I change my mind\u201d \u2014 and openly adopt a new inflation target.<\/p>\n

\u2014 The Fed could adopt a policy of strategic hypocrisy, insisting that its target hasn\u2019t changed while in practice allowing inflation close to 3 per cent for several years; then, once it has become clear that such a policy won\u2019t allow runaway inflation, finally change the formal target.<\/p>\n

\u2014 The Fed could put its money (supply) where its mouth is and do whatever it takes to get inflation all the way back down to 2 per cent, even if this involves a recession.<\/p>\n

As far as I can tell, Option 1 just isn\u2019t on the table. Option 2 looks like the most likely strategy. But it\u2019s possible that the Fed will feel obliged to prove its toughness by getting back to 2 per cent, even though that\u2019s probably bad economics.<\/p>\n

If the Fed does seem to be going that route, however, policymakers should be challenged: Should workers really be asked to lose their jobs for someone else\u2019s mistake?<\/p>\n

This article originally appeared in The New York Times.<\/strong><\/p>\n

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion.<\/i><\/b> Sign up to get it every weekday morning<\/i><\/b>.<\/i><\/b><\/p>\n

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