After the Fed failed to spark any notable increase in aggregate demand despite keeping interest rates at zero for seven years, a group of economists is pressuring the central bank to rethink one of its most closely held-policy parameters.
The group of 22 economists, which includes Nobel laureate Joseph Stiglitz and former Minneapolis Fed President Narayana Kocherlakota, delivered a letter to the Fed on Friday pressuring it to appoint a blue-ribbon commission to reevaluate its policy targets in a way that’s transparent and also involves officials with a diversity of viewpoints. Ultimately, the group hopes the central bank will reevaluate its inflation target, which has stood at just below 2% since 2012.
Borrowing the reasoning from a paper published by the San Francisco Fed earlier this year called “Monetary Policy in a Low R-Star World,” the group argued that structural shifts in the US economy appear to have shifted the real rate of interest permanently lower – and that the US economy can now tolerate higher inflation as a form of compensation.
Here's a passage from the letter:
“Even if a 2 percent inflation target set an appropriate balance a decade ago, it is increasingly clear that the underlying changes in the economy would mean that, whatever the correct rate was then, it would be higher today. To ensure the future effectiveness of monetary policy in stabilizing the economy after negative shocks – specifically, to avoid the zero lower bound on the funds rate – this fall in the neutral rate may well need to be met with an increase in the long-run inflation target set by the Fed.”
Such a reassessment would be particularly appropriate now, the economists argue, because “the lack of evidence that moderately higher inflation would harm Americans’ standard of living is juxtaposed with the tremendous evidence that a tighter labor market would improve Americans’ standards of living.”
Some Fed officials have already expressed tentative support for raising the inflation target, or at least changing the system by which the central bank’s parameters are set.
Williams noted the need for the Fed “to adapt policy to changing economic circumstances” in his paper, and Boston Fed President Eric Rosengren has said that the Fed should adapt policy to changing circumstances. Vice Fed Chairman Stanley Fischer has praised the system adopted by the Bank of Canada, where policy targets are reviewed every five years, then re-set with the participation of the legislature.
The argument for why a central bank should aim to push consumer prices even higher might seem obtuse to some readers - so Kocherlakota explained his reasoning for signing the letter in a column published by Bloomberg.
Raising the inflation target would give the Fed more room to maneuver during the next slowdown by allowing it to focus on reining in inflation if benchmark rates are already low, Kocherlakota said. “If, for example, people expect inflation to be 3 percent, then a zero nominal rate translates into a negative 3 percent real rate -- a full percentage point lower than the Fed could achieve if expected inflation were 2 percent.”
Experience suggests the Fed could use the support. During the most recent period of near-zero interest rates, the U.S. unemployment rate remained above 5 percent for nearly seven and a half years. And Yellen has suggested that, if another recession takes the Fed to the zero lower bound, the unemployment rate might stay above 5 percent for close to five years.
But while the Bureau of Labor Statistic’s seasonally adjusted CPI slumped to a 19-month low in April, other measures, like a gauge of consumer prices from PriceStat, have consistently recorded higher levels of inflation.
And regardless of what the rate of price growth is right now, the hard truth of the situation for many American workers is that real average wage growth is mired in the red while average household debt levels have climbed to record highs.
While many would welcome higher wages and better jobs, the relationship between inflation and employment – as Janet Yellen herself admitted – has seemingly broken down. Whether the central bank can successfully push inflation higher is up for debate; it has struggled in recent years – despite pumping trillions of dollars into the economy. But regardless, higher consumer prices are not what Americans need right now.
In addition to Stiglitz and Kocherlakota, the letter a signed by Dean Baker from the Center of Economic and Policy Research, Heather Boushey, from Washington Center for Equitable Growth, Brad DeLong, University of California, Berkeley, Joseph Gagnon, Peterson Institute, Lawrence Mishel, Economic Policy Institute, William Spriggs, Howard University, Valerie Wilson, Economic Policy Institute, Gene Sperling, Obama Administration Economist, Jared Furman, Peterson Institute, Marc Jarsulic, Center for American Progress, Lawrence Bell, Johns Hopkins University, Josh Bivens, Economic Policy Institute, Tim Duy, University of Oregon, Manuel Pastor, University of Southern California, Mark Thoma, University of Oregon, Justin Wolfers, University of Michigan, David Blanchflower, Dartmouth College, Mike Konczal, Roosevelt Institute, Michael Madowitz, Center for American Progress.
Read the full text of the letter below:
Dear Chair Yellen and the Board of Governors,
The end of this year will mark ten years since the beginning of the Great Recession. This recession and the slow recovery that followed was extraordinarily damaging to the livelihoods and financial security of tens of millions of American households. Accordingly, it should provoke a serious reappraisal of the key parameters governing macroeconomic policy.
One of these key parameters is the rate of inflation targeted by the Federal Reserve. In years past, a 2 percent inflation target seemed to give ample leverage with which the Fed could lower real interest rates. But given the evidence that the equilibrium interest rate had fallen substantially even prior to the financial crisis, and that the Fed’s short-term policy rate remained at zero for seven years without sparking any large acceleration of aggregate demand growth, a reassessment of this target seems warranted. Such a reassessment is particularly appropriate when the lack of evidence that moderately higher inflation would harm Americans’ standard of living is juxtaposed with the tremendous evidence that a tighter labor market would improve Americans’ standards of living.
Some Federal Reserve policymakers have acknowledged these shifting realities and indicated their willingness to reconsider the appropriate target level. For example, San Francisco Federal Reserve President John Williams noted the need for central banks to “adapt policy to changing economic circumstances,” in suggesting a higher inflation target, and Boston Federal Reserve President Eric Rosengren cited the different context in which the inflation target was set in emphasizing the need for debate about the right target. In May, Vice Chair Stanley Fischer highlighted the Canadian system of reconsidering the inflation target every five years, saying, “I can envisage – say, in the case of inflation targeting – a procedure in which you change the target or you change the other variables that are involved on some regular basis and through some regular participation.”
The comments made by Fischer, Rosengren, and Williams all underscore the ample evidence that the long-term neutral rate of interest may have fallen. Even if a 2 percent inflation target set an appropriate balance a decade ago, it is increasingly clear that the underlying changes in the economy would mean that, whatever the correct rate was then, it would be higher today. To ensure the future effectiveness of monetary policy in stabilizing the economy after negative shocks – specifically, to avoid the zero lower bound on the funds rate – this fall in the neutral rate may well need to be met with an increase in the long-run inflation target set by the Fed.
More immediately, new, post-crisis economic conditions suggest that a reiteration of the meaning of the Fed’s current target is in order. In its 2016 statement of long-run goals and strategy, the Federal Open Market Committee wrote: “The Committee would be concerned if inflation were running persistently above or below this objective.” Some FOMC participants, however, appear to instead consider 2 percent a hard ceiling that should never be breached, and justify their decision-making on that basis. It is important that the Federal Reserve makes clear – and operates policy based on – its stated goal that it aims to avoid inflation being either below or above its target.
Economies change over time. Recent decades have seen growing evidence that developed economies have harder times generating faster growth in aggregate demand than in decades past. Policymakers must be willing to rigorously assess the costs and benefits of previously-accepted policy parameters in response to economic changes. One of these key parameters that should be rigorously reassessed is the very low inflation targets that have guided monetary policy in recent decades. We believe that the Fed should appoint a diverse and representative blue ribbon commission with expertise, integrity, and transparency to evaluate and expeditiously recommend a path forward on these questions. We believe such a process will strengthen the Fed as an institution and its conduct of monetary policy, and help ensure wise policymaking for the years and decades to come.
The endgame, of course, is to pay off the old 'expensive' dollars with new 'cheap' dollars... quietly taxing the citizenry to death...