Starting off with a disclaimer: I don’t support raising the inflation target today, per se. The purpose of this post is to discuss a post by David Glasner that criticizes George Selgin for suggesting that it could help get a much stronger recovery.
Here’s what George Selgin had to say regarding raising the inflation target:
[T]his isn’t the first time that we’ve been in a situation like the present one. There was at least one other occasion when the U.S. economy, having been humming along nicely with the inflation rate of 2% and an unemployment rate between 5% and 6%, slid into a recession. Eventually the unemployment rate was 7%, the inflation rate was only 1%, and the federal funds rate was within a percentage point of the zero lower bound. Fortunately for the American public, some well-placed (mostly Keynesian) economists came to the rescue, by arguing that the way to get unemployment back down was to aim for a higher inflation rate: a rate of about 4% a year, they figured, should suffice to get the unemployment rate down to 4%–a much lower rate than anyone dares to hope for today.
I’m puzzled and frustrated because, that time around, the Fed took the experts’ advice and it worked like a charm. The federal funds rate quickly achieved lift-off (within a year it had risen almost 100 basis points, from 1.17% to 2.15%). Before you could say “investment multiplier” the inflation and unemployment numbers were improving steadily. Within a few years inflation had reached 4%, and unemployment had declined to 4%–just as those (mostly Keynesian) experts had predicted.
So why are these crazy inflation hawks trying to prevent us from resorting again to a policy that worked such wonders in the past? Do they just love seeing all those millions of workers without jobs? Or is it simply that they don’t care about job
Here is David Glasner summing up George’s comments on the subject:
Cleverly suggesting that the decision to use monetary expansion, and an implied higher tolerance for inflation, to reduce unemployment from the 7% rate to which it had risen in 1961 was the ultimate cause of the high inflation of the late 1960s and early 1970s, and, presumably, the stagflation of the mid- and late-1970s, George is inviting his readers to conclude that raising the inflation target today would have similarly disastrous results.
Is that really what George said? I will leave George to defend himself; but this isn’t either what George said or what happened that caused the Great Inflation of the 1970’s – because a 4% target is a 4% target, not 10-15%. This quote from Okun by Marcus Nunes is more along the lines of what happened to cause the Great Inflation:
The strategy of economic policy was reformulated in the sixties. The revised strategy emphasized, as standard for judging economic performance, whether the economy was living up to its potential rather than merely whether it was advancing…the focus on the gap between potential and actual output provided a new scale for the evaluation of economic performance, replacing the dichotomized business cycle standard which viewed expansion as satisfactory and recession as unsatisfactory. This new scale of evaluation, in turn, led to greater activism in economic policy: As long as the economy was not realizing its potential, improvement was needed and government had a responsibility to promote it. Finally, the promotion of expansion along the path of potential was viewed as the best defense against recession. Two recessions emerged in the 1957-60 period because expansions had not had enough vigor to be self-sustaining. The slow advance failed to make full use of existing capital; hence, incentives to invest deteriorated and the economy turned down. In light of the conclusion that anemic recoveries are likely to die young, the emphasis was shifted from curative to preventive measures. The objective was to promote brisk advance in order to make prosperity durable and self-sustaining…The adoption of these principles led to a more active stabilization policy. The activist strategy was the key that unlocked the door to sustained expansion in the 1960s.
It was the Fed’s focus like a laser beam on employment out of lack of a more complete understanding of the Philips Curve that caused the Great Inflation, not a 4% inflation target. We have nearly the same problem today, only in reverse, with the Fed focused like a laser beam on inflation claiming to have little or no impact on employment – which we know, or should know, that it is absurd for Fed officials to pretend like everything we learned about the economics of the 60’s and 70’s simply vanished or never existed.
Aside from George not having suggested that we embark on another episode of the Great Inflation, but instead suggested that a 4% inflation target helped to remedy the economic troubles of the early 60’s, I don’t believe that a higher inflation target makes sense or would work for two reasons (at least). The first is that the Fed has defined price stability at 2% inflation per year and it hasn’t delivered. Even if we did adopt a 4% target, it would make no material difference to the present monetary dynamics of satisfaction with being below target, treating various measures of inflation interchangeably to suit itself. The second problem is that it is politically unworkable – inflation isn’t what people want; and I apologize for stating the obvious. They want a functional employment market. They want opportunity. They want rising standards of living.
All of this implies that the Fed should moderate and provide balance rather than being periodically obsessed with the wrong variables and denying responsibility– which might mean that even NGDPLT could have its unforeseen bumps in the road. If such a target were ever adopted and bumps in the were to be discovered, I would expect no less than the people who are smarter than me to recognize there is a problem and fix it before it gets as far out of hand as the Great Inflation did and the Great Recession has. But one cannot fix a bump in the road that one refuses to see. I don’t have any suggestions for how to make blind people see, except that in many cases accountability that bears fangs seems to cure lack of due diligence and accumulation of sycophancy.