The US Federal Reserve’s preoccupation with “temporary” inflation was short-lived. On Tuesday, Fed Chairman Jerome Powell told the Senate Banking Committee: “I think it’s probably a good time to retire that word and try to explain more clearly what we mean.” Agreed. There was never a question critical to monetary policy that analysts have debated with the Fed’s stimulus: whether the recent surge in inflation was transient or persistent. This is how policy should be set, given that no one knows.
A group of commentators said the price rise was a blow to short-term disruptions to the pandemic’s supply and should be mostly ignored for monetary policy purposes. Another said it is more severe, that inflationary pressures are affecting a wide range of goods and services, pushing wages higher, and threatening to usher in high inflation unless demand restrains. is not imposed.
Powell has shifted his allegiance to another group, and you can see why. Inflation in both the US and Europe is much higher than central banks expected earlier this year, and is no longer confined to the parts of the economy directly affected by the pandemic. Granted, according to market-based indicators, investors are expecting US inflation to fall below the Fed’s 2% target within a few years, and remain at 2% or so after that. But it is a condition of how monetary policy will respond to inflationary pressures over the medium term, not a judgment about the current mismatch between demand and supply.
Eventually, there’s no doubt that the bottlenecks will be lifted, supply will recover and inflationary pressures will ease – partly thanks to the slightly faster pace of monetary tightening that Powell just promised. In other words: inflation is more likely to be transitory now that Powell has said it may not.
But the main thing is that no one knows how much inflation will fall, or how soon. Omicron Edition has added new unknowns. More variants may follow. Further cycles of disruption and recovery will only add to the confusion.
The Fed’s most important function was to support demand, and it is. Inflation expectations suggest that, at least for now, staying on top of the problem is still credible. But the Fed’s current policy framework — its self-imposed rules for how it forms and interprets its decisions — makes this task more difficult than it should be. The Fed’s “flexible average inflation targeting” (or FAIT), obliges it to defend decisions it doesn’t need to make.
There’s a better way. Instead of interpreting policy in terms of separate targets for inflation and employment, the US Fed should announce a target for nominal gross domestic product (NGDP), a measure combining output and inflation – price, At current prices, that produces the economy. , In effect, it merges both sides of its dual mandate into a single measure.
It has great advantages. Firstly, it’s easy. Month by month, instead of revisiting the conflicting meanings of ‘maximum employment’ and ‘average inflation’, the Fed will measure monetary policy’s stance against the gradual growth of a straight aggregate. Second, it’s honest about what the Fed can expect to do with monetary policy. Changes in interest rates and/or central bank bond purchases do not directly affect jobs and prices. In the first instance, they carry the NGDP; How this change affects jobs and prices is beyond the control of the Fed. A third benefit is particularly valuable right now. An NGDP target copes more readily with supply-side shocks. Under the Fed’s current approach, supply disruptions that reduce output and raise prices pose a policy dilemma: should it prioritize controlling inflation or supporting employment? Tackling that dilemma is why the Fed and its army of spectators are debating whether inflation is fleeting. With the goal of NGDP, there is no need to ask often. When supply is hit, inflation is allowed to rise until production recovers and NGDP is back on track. For example, a 4% increase in NGDP makes inflation “on target” of 4% when output growth falls to zero.
It so happens that the NGDP is now broadly back to its pre-pandemic trend. This suggests a need to curb its future growth, and is in line with the emphasis of Powell’s latest comments. Probably, thinking about NGDP has always been guiding the Fed. If yes, why hide it? As Powell just proved, it’s much harder for the Fed to convince itself — and there’s a huge risk of confusing investors and undermining central bank credibility — if it keeps suggesting it can. which he cannot do.
Eliminate the word ‘transient’. But then try ngdp. It is better for the Fed to offer a simpler and more modest account of its powers, rather than pretending that it can simultaneously strike two shifting, vaguely defined and sometimes conflicting targets.
Clive Crook is a Bloomberg Opinion columnist and writes editorials on economics, finance and politics
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