“Bad Options” Regarding 2% Inflation Targets (And Other Silly Notions)
Mike “Mish” Shedlock
The Wall Street Journal and Bloomberg both posted ridiculous articles regarding today regarding inflation.
The former was on “bad options” the latter on “inflation expectations”.
Let’s take a look at both articles because both represent widely believed nonsense.
In Bad Options for Addressing Too-Low Inflation, Wall Street Journal writer Greg Ip says the Fed’s choice is to overheat the economy or give up its 2% target.
Unemployment and inflation are near their lowest levels in decades. Who wouldn’t love that?
Janet Yellen, for starters.
What looks like a dream economy could be a nightmare for the Federal Reserve chairwoman. Ms. Yellen’s worldview assumes that when unemployment is this low—4.4% in August—inflation should move up to the Fed’s target of 2%. Instead, it may have stabilized around 1.5%. That presents the Fed with some unpalatable options: deliberately overheat the economy for years to get inflation back up, then potentially induce a recession to stop it from overshooting; or give up on the 2% target, which could hobble its ability to combat future recessions.
This isn’t scaremongering: It’s the logical consequence of how central banks believe inflation operates. At the center of their model is the Phillips curve, according to which inflation edges lower when unemployment is above its natural, equilibrium level and putting downward pressure on prices and wages. Below that natural rate, also known as full employment, inflation crawls higher.
Until recently, Fed officials scoffed at the possibility [Trend inflation has fallen]. They noted surveys that suggest the public still expects inflation to return to 2% and credit their oft-repeated promise to hit their 2% target. But are they fooling themselves? Expectations of inflation are determined in great part by what inflation actually has been, and after every recession since 1982, core inflation has averaged less than in the previous business cycle: 4.1% in the 1980s, 2.1% in the 1990s, 1.9% in the 2000s, and 1.5% since 2009.
To get inflation higher, the Fed would have to engineer the opposite of the past 35 years: a prolonged boom that drives unemployment below its natural rate until inflation returns to 2%. As actual inflation rises, so would expectations, locking in the higher trend. To achieve this, Ms. Brainard suggests interest rates shouldn’t rise much more, if at all.
This approach could aggravate another worry: financial excess. If stocks and property look bubbly now, imagine what five more years of very low interest rates would do.
The alternative is to ditch the 2% target and accept 1.5% as the new inflation trend. Besides shredding the Fed’s credibility, that would mean lower trend interest rates and thus less rate-cutting ammunition to fend off the next recession. If history is any guide, that recession would push trend inflation down further.
There is so much utter nonsense in those paragraphs I hardly know where to start. But we have to start somewhere.
- It’s widely known that the Phillips Curve is totally discredited. That Janet Yellen still has faith in the curve is proof enough of her incompetence. For discussion, please see Fed Study Shows Phillips Curve Is Useless: Admitting the Obvious.
- Inflation expectations are nonsense. People believe inflation will be 2% simply because economic illiterates at the Fed and in mainstream media repeat 2% at every turn. Repeat lies often enough and people regurgitate them whether they really believe them or not!
- Credibility? Please be serious. The following chart tells you all you need to know about credibility.
Twelve Thumbs Down
The Fed has no credibility and it’s ludicrous for Greg Ip to propose otherwise.
That was a sorry, sorry article. I have agreed with Ip on many occasions. His latest gets 12 thumbs down.
Here’s the ironic kicker to this sorry saga: Bloomberg reports Fed Officials Admit They’ve Lost Some Credibility on Inflation.
After years of maintaining that inflation expectations were stable and solidly grounded, Fed policy makers are starting to recognize a small but worrying softening in the outlook that consumers, businesses and investors have for prices.
“They’re acknowledging that the inflationary anchor has slipped a bit,” said Ethan Harris, head of global economics research at Bank of America Merrill Lynch in New York.
“There is no single highly reliable measure” of longer-run inflation expectations, Fed Governor Lael Brainard told The Economic Club of New York on Sept. 5. “Nonetheless, a variety of measures suggest underlying trend inflation may currently be lower than it was before the crisis” of 2008-2009.
Michael Feroli, chief U.S. economist at JPMorgan Chase & Co., said he didn’t think that Yellen was overly concerned by what might be a slight shift down in the inflation outlook of consumers and companies. She would though become more worried if they deteriorated further, he said.
Although Fed officials are increasingly open to the idea that expectations have slipped, none have gone so far as to say that they’ve become completely untethered.
“Unanchored is kind of like a four letter word for central bankers,” Bank of America’s Harris said. “I don’t think expectations are unanchored, but I do think the Fed has lost a little bit of credibility for achieving its 2 percent target.”
No Reliable Measures
“There is no single highly reliable measure” of longer-run inflation expectations, Fed Governor Lael Brainard told The Economic Club of New York on Sept. 5.
Lovely. He’s also correct. Yet, he proposes to know what to do about it! How idiotic is that?
Let’s get straight to the point that Bloomberg missed and Greg Ip missed.
Why does anyone think they know the correct amount of inflation in the first place?!
Here’s the deal: I don’t know, nor does Greg Ip, nor does Bloomberg, nor do any of the clowns at the Fed. Yet, we have idiotic discussions about “bad options” to achieve targets that are undoubtedly bad, and cannot be accurately measured in the first place!
Yet, we have idiotic discussions about “bad options” to achieve targets that are undoubtedly bad and cannot be accurately measured in the first place!
Three successive bubbles and decades of missed targets with the Fed chasing its tail are proof enough.
Greg IP needs some help. I suggest Debunking MMT, Keynesianism, Monetarism: Reader asks “What theories do you believe?” Mish Reading List
Economic Challenge to Keynesians
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.
- My article Deflation Bonanza! (And the Fool’s Mission to Stop It) has a good synopsis.
- My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.
There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced.
BIS Deflation Study
The BIS did a historical study and found routine deflation was not any problem at all.
“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study.
It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.
Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.
For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?
Finally, and as a measure of insurance against the Fed’s clueless tactics, please consider How Much Gold Should the Common Man Own?
Mike “Mish” Shedlock
Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management.
You are currently viewing “MikshTalk” my global economics blog where I typically write several articles a day topics such as interest rates and central bank policy, gold and precious metals, jobs, and economic reports, all from an Austrian Economic perspective.