You’ve given me a lot to chew on. So it’s taken me a bit to cogitate and put together a cogent reply.
No that is not true, there is no mention of an inflation target by Congress in the Federal Reserve Bank Act of 1913 or in any amendments.
Congress has never set a mandatory inflation rate in any Bill.
Perhaps I stated things poorly. The Fed is tasked with maintaining stable prices. That is clearly in the Federal Reserve Act.
The Fed Governors chose, about a decade ago, to use 2% inflation as their benchmark for stable prices.
Like I said in my previous reply, you could argue for a different benchmark rate. But I don’t think you can argue that seeking price stability it outside of the Fed’s scope. So when you start saying that setting a benchmark for inflation is solely a made up process from the Fed, I have to disagree. Their mandate - one of their reasons for existence - it to maintain stable prices. Setting a benchmark seems to be well within the Fed’s mandate for stable prices. That is one way they are attempting to achieve stable prices.
There are advantages to stating a benchmark rate. Businesses can anticipate that as the inflation rate gets further away from that benchmark, the Fed will take actions to push inflation back towards that benchmark. That takes some uncertainty out of various markets, allowing market participants to predict what the Fed will do so that businesses are not surprised by the Fed’s actions.
Even after Bernanke made the announcement he said “I don’t see anything magical about targeting 2% inflation.”
Let’s read that statement in context.
Although we did not adopt one of these alternatives, I will say that I don’t see anything magical about targeting two percent inflation. My advocacy of inflation targets as an academic and Fed governor was based much more on the transparency and communication advantages of the approach and not as much on the specific choice of target. Bolding mine.
(Alternatives here were potential targets for price level or some function of GDP.)
Bernanke actually advocated for some kind of targets for that “stable prices” mandate. They provide for transparency to the Fed’s decision making and help communicate what the Fed is likely to do in various situations.
And that gets back to what I’ve said a couple of times. If you don’t like the 2% target, argue for a different target. Or argue for a GDP target instead of an inflation target.
David Wessel, in the article you linked, gives a bit more background.
In 1996, Fed policymakers privately agreed that their target for inflation was 2 percent, but, at
Greenspan’s insistence, they didn’t tell anyone.
So the 2% target has been around for much longer than a decade.
He goes on to state:
In fact, inflation fell short of the Fed’s 2 percent target for much of the past decade.
Umm. So what? He was writing in 2018, about a decade after the 2008/2009 financial crisis. Starting about that time, the Fed lowered their overnight rate to roughly zero. At the beginning of 2008, the target rate stood at 3.5%. By the end of the year, it was at 0.25%, where it stayed for 7 full years! http://www.fedprimerate.com/fedfundsrate/federal_funds_rate_…
The Fed was stimulating the heck out of the economy and inflation was staying low. Going into negative overnight rate territory is getting into uncharted waters. It risks starting up a deflationary spiral, which hasn’t really happened since the Great Depression. Rather than take that unprecedented step, they took a different unprecedented step, lending money out for longer terms. They started buying US Treasury bonds of all different maturities, effectively giving the Federal government money to spend to stimulate the economy. While the Fed had never done this before in the modern era, at least the macroeconomic theory of creating and lending money was reasonably well understood. It should be inflationary. (And frankly, it was - in everything BUT consumer prices.)
So the Fed was doing all it dared do to keep out of deflation. I don’t think being a bit short of their target inflation rate is all that much of a problem, considering what they were doing to keep the inflation rate up.
However, the bulk of the article is not really a condemnation of an inflation target. It is merely questioning whether 2% inflation is the right target, and discussions of alternative potential targets. It is essentially a rehash of the discussions the Fed itself had back in the 1980s and 1990s before deciding on the current 2% inflation target.
In thinking about it, I don’t see where Wessel really considers the effect of the 40 years of steadily falling interest rates. At its high in 1981, the Fed Funds rate was at 20%. It fell off those highs fairly quickly, but still stood at 8.25% at the end of the 1980s. In the 1990s, it went as low as 3% during the 1991/1992 recession, but was back to the 5-6% range for the rest of the decade, ending 1999 at 5.5%. We last saw 6% in January 2001. The last 5% rate was in 2007, and we were to effectively 0% at the end of 2008, staying there until the December 2015 meeting. Since then, there was a high at 2.5% during the first half of 2019, with a trip back to zero for Covid and then back up to 2.5% today.
Wessel’s argument for a higher inflation target seems to stem from his belief that the “neutral” interest rate (the nominal rate minus inflation) has fallen to 2% or less. He even has the audacity to toss out a strawman rate of 3%, citing a paper where the highest mentioned neutral rate was 2%.
Putting that aside, his argument is that because the neutral interest rate is more like 1%, the Fed’s target inflation rate should be more like 4%. That gives the Fed more room to drop interest rates during a recession before hitting the zero bound.
Personally, I think the long bull market in bonds (bond values increasing while interest rates fall) is disguising the natural interest rate. So many people (read Baby Boomers) have been putting so much money away for retirement, that they’ve bid down the returns on bonds. Once that trend starts to reverse - which will happen over the next decade or less as Boomers start dying off in big numbers - less money will be available for lending and the neutral interest rate will get back to the 2.0 - 2.5% range where I think it lies. With a 2% inflation target on top of the neutral interest rates, that puts nominal rates in the 4.0 - 4.5% range. Since nominal rates of 5% are likely desirable to reduce the risk of running into the zero bound during recessions, perhaps an inflation target of 2.5% would make some sense. I can’t entirely disagree with that.
Larry Summers makes an argument for an even higher target of 4%. He combines that with a 1% neutral rate to get to a nominal 5% interest rate.
Let’s get to Reich. I assume you’re talking about this quote, and the brief article it came from:
The Fed is trying to douse a fire in the living room, when the forest is ablaze.
Yes, but I read it much differently from you. I read it as him calling for Congress and governments around the world to act, not as a condemnation of what the Fed is doing. The Fed is doing what they must, even though everyone - Fed governors included - knows it is not enough.
If that is NOT what he’s saying - if he’s saying that the Fed should stop raising interest rates - well, then Reich is wrong. At least from my point of view.
His suggestions include a windfall profits tax, price controls, antitrust enforcement, and general tax increases.
I lived through the windfall profits tax on oil and gas in the 1980s. It wasn’t effective then, and it won’t be now. The problem with oil and gas is a shortage - both then and now. Taxing profits won’t help produce more supply. All that will happen is that the price of oil and gas (and the products of refining them) will go up even further.
Price controls in the 1970s didn’t work to contain inflation. They reduced producers’ incentives to produce. But we want to INcrease their incentive to produce more. We learned that lesson - let’s not repeat that mistake.
Antitrust enforcement - I could get behind that. But I fail to see how it would impact inflation in time to do any good. Effective enforcement takes years, not months. It’s worth doing to help stave off the next bout of inflation.
Tax increases. I agree with them, but again, good luck. I’m enough of a realist to understand that there will not be any meaningful tax increases coming from this Congress. And if leadership of one or both houses change in the coming election, the odds only get worse.
And… I never said that the Fed should do nothing, but pushing the cost of borrowing for mortgages over 10% is where they are headed.
At least we agree that the Fed should be doing something. The cost of mortgages going over 10% is just fear mongering. They’re currently in the mid 5% range.
And… Inflation is already showing signs of easing
Which is why mortgages will not get up to the heights you fear.
And… One of the Congressional mandates is Maximum Employment. The Fed stated that they are not going to use unemployment as a guide to the current steps in stemming inflation.
That’s not exactly true. Here’s what the Fed did say: the Fed said in August 2020 that it would respond to “shortfalls of employment from its maximum level” rather than the previous “deviations from its maximum level.”
https://www.brookings.edu/blog/up-front/2022/02/23/how-does-…
In other words, they used to be concerned about exceptionally low unemployment as being inflationary. Now they are only going to look at low employment (or high unemployment) as something to worry about. If unemployment gets very low, they are going to respond to actual inflation, not the risk of inflation that low unemployment poses absent any actual inflation.
To summarize, I still think the Fed is doing exactly what they must do. Even if you want to argue for an inflation target of 4% and believe the neutral rate is 1%, that still means the Fed Funds rate should be 5%. And it’s at 2.5% today. So further Fed Funds rate increases are in order. We are still below the expected nominal rate needed to be neutral. And that means the current rate is still stimulating the economy. And when supply is constrained, stimulating the economy is only going to result in inflation, not actual economic growth.
–Peter