The problem with monetary hawks is that they are always looking for an excuse for tighter money. Doves have the opposite problem, a bias toward easier money. Recent events provide a good example.
I see lots of doves now talking as if getting inflation back to 2% should be viewed as the ideal. But that’s wrong; we have a “flexible average inflation target”. Inflation is supposed to average 2% over the long run, but not each and every year.
Back in 2022, doves correctly pointed out that it was appropriate to allow a period of above 2% inflation, as the economy was buffeted by negative supply shocks (Ukraine, Covid, etc.) But that same logic suggests that the current inflation rate should be well below 2%.
The US is currently experiencing a strong positive supply shock, driven most by sharply increased immigration but also the repair of damaged supply chains. If inflation is to average 2% over the long run, then inflationary periods of negative supply shocks such as 2022 must be offset by lower than average inflation during periods of positive supply shocks.
Under 4% NGDP targeting, we might currently be experiencing 2.5% RGDP growth and 1.5% inflation. Unfortunately, NGDP growth remains up around 6%, which is much too high.
To summarize, doves are correct that there are times when it is appropriate to allow above 2% inflation. But the logic of that argument is symmetrical—something many doves fail to understand.
READER COMMENTS
Michael Sandifer
Feb 24 2024 at 8:38pm
Yes, there’s every indication that 6% NGDP growth is unsustainable, but current or recent numbers aren’t what count. The forward-looking metrics have been indicating both a slowdown in inflation and NGDP for months. Just over the past couple of weeks, there are hints that expected NGDP growth got a bit too high again, so a delay in lowering rates versus prior expectations might be warranted.
Bobster
Feb 25 2024 at 4:37pm
What forward looking metrics?
Michael Sandifer
Feb 26 2024 at 7:29pm
The most important one with regard to an inflation-targeting central bank is the inflation breakeven. I focus mainly on the 5-year, but there can be surprising complexity in the curve at times.
Thomas L Hutcheson
Feb 24 2024 at 10:40pm
No. The target should be forward looking, not backward looking at the extraordinary inflation needed to deal with the extraordinary shocks of first lockdowns and then services => goods shift. The 2% target is for the average level of sectoral shocks going forward.
spencer
Feb 25 2024 at 8:56am
The FED’s 2% excludes asset price inflation. The wealth effect is actually impoverishing.
Jeff
Feb 27 2024 at 3:59pm
It’s hard to avoid the impression that some support for asset prices is intended in the Fed’s rather selective choices about how aggressively to pursue their inflation target. But doesn’t that strategy eventually just push the government’s cost of capital to converge with that of the private sector? Why would investors accept a lower return for the same level of risk?
Bob
Feb 25 2024 at 10:23pm
A lot of commentators seem to be arguing that the cost of running the economy a bit hot is low, and that in fact there are benefits to it.
They seem to think keeping inflation a bit above target isn’t a big deal, and we should actually cut to forestall a recession.
Why are they wrong? Indeed it seems like the stock market is booming and real wage growth is back to positive. What’s the horrible thing that will happen from continuing running things hot?
BS
Feb 26 2024 at 11:23am
People who can’t command wage increases or investment practices that allow them to keep up with inflation fall further behind than they would if inflation were lower.
Scott Sumner
Feb 26 2024 at 12:48pm
“What’s the horrible thing that will happen from continuing running things hot?”
The 1970s?
Bobster
Feb 26 2024 at 9:50pm
So do you think we’ll need rate hikes soon to tame inflation?
I do tend to agree, but the recent stock market performance gives me pause.
Scott Sumner
Feb 27 2024 at 12:36am
I don’t have strong views on where rates are headed. In my view, interest rate movements are almost unforecastable. I’d prefer the Fed stopped targeting interest rates.
Thomas L Hutcheson
Feb 29 2024 at 1:36pm
Agree, sort of. I would not say they “target” interest rates, but they do, unwisely, speculate about their future levels. This is inconsistent with data-driven FAIT.
spencer
Feb 26 2024 at 5:19pm
Outside money is not neutral. It is contractionary. It lowers the real rate of interest.
Mike Sproul
Feb 29 2024 at 12:21pm
The backing theory view says that the central bank need only make sure that every time it issues a dollar, it gets a dollar’s worth of assets in return. This assures that the central bank’s assets move in step with its money issue, so inflation is prevented. As long as this condition is met, the central bank should issue as much money as the public will receive. Its watchword should be “Never tight, always easy.”
Thomas L Hutcheson
Feb 29 2024 at 8:54pm
You have hit the key disadvantage of a gold standard; the central bank cannot produce the optimal amount of inflation, which varies over time and is never zero. Of course, neither can it produce horrifyingly super-optimum rates, so, you may think suboptimum is the best that can be done politically.
Hans Dramm
Mar 10 2024 at 8:37am
Accepting this perspective (as i do) raises the question of when the relevant period begins. Perhaps if considering the two to three ( and possibly more years prior to 2022) the current average may be lower. Especially if using geometric average.
Comments are closed.