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Home Market Research Economy

Mission Accomplished? – Econlib

by TheAdviserMagazine
4 months ago
in Economy
Reading Time: 2 mins read
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Mission Accomplished? – Econlib
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A recent Bloomberg article suggested that the Fed should declare victory over inflation:

Granted, it may feel premature, if not foolhardy, to declare “mission accomplished” on inflation. It’s not just the rise in tariffs and the fall in immigration; there are a lot of structural factors in the economy pointing to more inflation: more debt, an aging work force, slower productivity growth, and a world that trades less and is less reliant on the dollar. Still, declaring victory now will make it easier for the Fed to make policy in the future.

First, the days of an inflation rate below 2% may be behind us. If so, the Fed will need to internalize this truth in its communications and policies — or risk becoming too contractionary for too long in the future. When it undertakes its next framework review, it may need to increase its target rate from 2%. It can credibly do so now that inflation has been licked.

I’m not convinced that victory has been achieved, nor do I believe it would be a good time to raise the inflation target.  Here’s the 12-month rate of inflation using the core PCE indicator:

Core inflation has recently fallen to 2.5%, but that’s still above the Fed’s 2% target.  Furthermore, the Fed has a flexible inflation target.  Under that sort of policy regime, inflation should run a bit below 2% during booms and a bit above 2% during recessions.  We are clearly in an economic boom.

I do not see any good economic arguments for raising the inflation target above 2%.  More importantly, even if a higher inflation target were a good idea, the optimal time to raise the target would be during the next period of near-zero interest rates, not when short-term interest rates are above 4%.  The adoption of a higher inflation target can be a powerful tool for stimulating an economy stuck at the zero lower bound.

In general, I am skeptical of calls for raising the inflation target.  Doing so would reduce the credibility of the Fed, as investors would begin to doubt its commitment to low inflation.  This might make it even more difficult to bring inflation back down after it overshoots the target rate for an extended period of time.



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