The central bank should see if faster price increases lead to more jobs.
Federal Reserve policy makers have been saying for some time that low inflation is attributable to temporary forces that will disappear in the next two to three years. But recently the Fed’s own staff has also projected such a rapid return of inflation to the central bank’s target of 2 percent. This more optimistic forecast puts a key question before policy makers: Shouldn’t they be willing to aim even higher?
The Fed formally adopted a 2 percent inflation target in 2012. Inflation has been undershooting ever since. Neither the committee nor the public should be surprised by this. The Fed’s monetary policy meeting minutes (released three weeks after every meeting) show that its own staff has consistently predicted that, over their two- to three-year forecast horizon, policy choices would lead inflation to undershoot the target.
To give some feel for what I mean, here are the staff inflation outlooks from the June meetings in from 2012 to 2016 as documented in the minutes. (For those who are interested: I have written a more complete chronology here.)
- June 2012: Subdued through 2014
- June 2013: Relatively subdued through 2015
- June 2014: Below 2 percent during the next few years
- June 2015: Inflation below 2 percent through 2016 and 2017 1
- June 2016: Slightly below 2 percent in 2018
The staff has been sending a consistent public message: They didn’t see the Fed’s expected actions as being sufficiently stimulative to get inflation back to 2 percent within two to three years. (By way of contrast, the Bank of Canada — operating in what many might view as a more challenging monetary policy environment — typically aims to return inflation to its target within six to eight quarters.) Why the Fed made these hawkish choices — including a variety of tightening moves from June 2013 on — seems to me to be an important question for the public’s representatives in Congress to be asking.
The good news is that the minutes from last month’s Fed meeting reveal an important change relative to these past outlooks. The staff now projects that, based on their forecast of Fed monetary policy choices, inflation will return to target in 2019. In this sense, the Fed is (finally) making monetary policy choices that are supportive of its stated inflation goal.
This history raises a key issue for Fed policy makers: Since they tend to undershoot their inflation target for so long during tough economic times, shouldn’t they now be aiming higher than 2 percent when times are better? This is a question of whether the Fed sees 2 percent as more of a ceiling or an average. For most of the past decade, inflation has run below 2 percent.
Perhaps more importantly, it looks like this experience is likely to recur in the future: This speech by Fed Chair Janet Yellen suggests that we should expect another decade of sub-2 percent inflation in a future large recession. To achieve an average 2 percent inflation rate over the longer run, the Fed would have to offset these long stretches of sub-2 percent inflation with some periods of above-target inflation. The staff’s current and past outlooks seem to suggest that the Fed is unwilling to do so. That’s unfortunate, because that additional monetary stimulus wouldn’t just push inflation above 2 percent — it would also generate more and better jobs.