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One simple action Fed officials refuse to take could make their policies a lot more powerful

Aug 26, 2024, 07:19 IST
REUTERS/Gary CameronJason Furman, former Chairman of the Council of Economic AdvisorsThere is an easy step officials at the Federal Reserve could take to improve their ability to fight the next recession, but policymakers are deeply reluctant to go there: raising the central bank's 2% inflation target.

Several prominent economists, including former President Barack Obama's top economic advisor Jason Furman and Nobel laureate and Columbia University professor Joseph Stiglitz, have signed a letter proposing Fed officials do just that.

That's because with inflation chronically undershooting the Fed's goal and interest rates still below 1%, they worry the central bank may not have much room to ease monetary policy further the next time the economy runs into trouble.

"We should support a higher inflation target in addition to other measures that will make monetary policy making easier," Furman told reporters during a conference call sponsored by the Center for Popular Democracy and the Fed Up Coalition, which has been protesting the central bank's monetary tightening efforts. Other areas that should contribute to economic progress and financial stability, he said, are fiscal policy and regulation.

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The letter argues that because of changes in the economy, "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."

It calls for the appointment of a "diverse and representative blue ribbon commission with expertise, integrity, and transparency to evaluate and expeditiously recommend a path forward on these questions."

The Fed started raising interest rates in December 2015 after leaving them at zero since December 2008, and has lifted the federal funds rate higher two more times since. Most investors are counting on a fourth rate increase this coming week.

Central bank inflation targets are commonplace around the world, and the basic idea is to create a mental anchor for businesses and workers that will keep inflation and expectations thereof from either rising or falling too quickly.

The Fed's official mandate is low and stable inflation as well as maximum sustainable employment. In theory, the more the job market improves, the more likely inflation is to start pushing higher, as fewer available workers should lead to higher wages and prices. However, the recent recovery has puzzled Fed officials because an unemployment rate that is now at a historically low 4.3% rate has not pushed inflation or wages higher.

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Critics, including many of the economists signing the letter calling for a higher inflation target, say that's because the Fed did not go far enough in its stimulus, despite its extensive monetary easing and repeated bond-buying programs. Making the situation worse, fiscal policy has generally been tight to neutral during the recovery.

Low inflation sounds like a good thing, but if it's persistently below target and reflected in income stagnation, it can be a sign of a suboptimal economy and job market.

And the Fed has been chronically missing its inflation target for most of this economic recovery. Even so, Fed officials have resisted lifting their target, arguing that it could cost them credibility. Still, it's hard to argue that missing one's target for the better part of a decade is exactly credibility enhancing.

So what good would a higher target be if the Fed can't even get to 2% as is? The idea is that the central bank would have been forced to move even more aggressively to get there, and therefore the economy would now be on a stronger footing, rather than still struggling to hit a 2% annual rate of growth.

Over the long-run, the group of economists believes this will actually help the Fed be able to raise rates further during the next economic expansion, thus allowing it to rebuild monetary firepower depleted during the Great Recession.

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The following is the full list of economists who signed the letter in support of a higher inflation target.

Center for Popular Democracy

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