Frances Coppola, Columnist on CoinDesk, is a freelance writer and speaker on banking, finance and economics. His book “The Case for People’s Quantitative Easing” explains how modern money creation and quantitative easing work, and advocates “helicopter money” to help economies come out of recession.
The Federal Reserve has just announced a change in its inflation targeting regime. Instead of shooting to reach 2% every year, it will aim to reach 2% “on average” over an indefinite period of time. So, if inflation drops below the target in 2020 and 2021 due to a pandemic-induced recession, the Fed could allow inflation to exceed 2% and stay there in 2022 and 2023, thus reaching an average of 2% from 2020 to 2024. the idea is that by allowing inflation to rise “moderately”, the Fed could keep interest rates low and quantitative easing [QE] long enough to reach full employment, rather than starting to withdraw it before full employment is reached.
There is only one problem with this. There is absolutely no reason to think that temporarily raising the Fed’s inflation target would increase inflation.
Since the 2008 financial crisis, the Fed has struggled to meet its inflation target. As this chart shows, the Fed’s preferred measure of inflation, basic personal consumption expenditure (PCE), has rarely come close to 2%, let alone exceed it:
This is despite historically low interest rates and, lately, an extremely strong labor market. In his speech at the Jackson Hole conference, Federal Reserve Chairman Jay Powell said that the inverse relationship between inflation and unemployment, on which the Fed’s interest rate policy has traditionally been pressed, seems to be broken:
The historically strong labor market has not triggered a significant rise in inflation. Over the years, forecasts of [Federal Open Market Committee] Participants and private sector analysts have consistently shown a return to 2% inflation, but these predictions never materialized on a lasting basis.
Basically, until the pandemic hit everyone was working but they weren’t getting a pay raise. There was therefore no sustained upward pressure on consumer prices due to wage demands.
There was also no sustained inflationary pressure from money creation. One of the great mysteries of the past decade is QE’s failure to bring inflation back to the Fed’s target. All that new money should have set off an inflationary spiral – but it didn’t. Well, not in consumer prices, anyway, although it has inflated asset prices and continues to do so.
Of course, the Fed is far from the only central bank struggling to bring inflation down. The ECB has failed to meet its 2% target for the past decade. And the Bank of Japan has never managed to raise inflation above zero for any period of time, despite negative interest rates, massive QE programs and the world’s largest public debt.
See also: Commentary: Fed Chairman Jerome Powell Details Inflation Target Changes
But why is the Fed so determined to bring inflation down, anyway? Isn’t inflation an unfair tax for savers? Is deflation not a good thing for consumers? According to Mr. Powell, “Constantly too low inflation can pose serious risks to the economy. Inflation below its desired level can lead to an unwanted drop in long-term inflation expectations, which in turn can push real inflation even lower, leading to an unfavorable cycle of inflation and expectations. ever lower inflation. “
This is the dreaded “deflation spiral” described by the American economist Irving Fisher in his essay “The Debt Deflation Theory of Great Depressions”. When there is sustained deflation, those who owe money are increasingly in debt. As Fisher said, “the more debtors pay, the more they owe”.
In today’s indebted economy, US households and businesses are too indebted to cope with sustained deflation. Low and stable inflation gives them at least a chance to pay off their debts. If we are to have any chance of reducing the dominance of private sector debt in the economy, deflation must be avoided at all costs.
But too high inflation is also bad. It discourages savings and punishes those who have managed their finances prudently. Most people agree that the double-digit inflation of the 1970s was way too high. In this new regime, the question is how high will the Fed allow inflation to rise? Right now, we don’t know – and it’s not a recipe for confidence in the new Fed framework.
But if Japan has something to do, the new Fed framework won’t make any difference anyway. In 2013, the Bank of Japan raised its inflation target from 1% to 2%. Six years later, there was virtually no effect on real inflation. The ability of a central bank to increase inflation is limited by its tools. The evidence seems to be that when interest rates are nailed to the floor, as they have been in Japan for more than a quarter of a century, the tools central banks have, like QE and cheap funds for banks , are just not very effective in increasing inflation.
Jay Powell’s problem, and indeed the problem that all central bankers face, is that he can’t give people money directly.
This is not the first time that US policymakers have announced a rise in inflation in the absence of policies that could create it. In December 1933, The New York Times published an open letter to President Franklin D. Roosevelt from British economist John Maynard Keynes. In it, Keynes sharply criticized Roosevelt’s plan to raise prices:
“Too much emphasis on the remedial value of a higher price level as an object in itself can lead to serious misunderstandings as to the role that prices can play in the recovery technique. Stimulating production by increasing overall purchasing power is the right way to raise prices; and not the other way around.
And he then complained about the disproportionate role of money creation in Roosevelt’s plans:
“Rising production and rising incomes will sooner or later suffer a setback if the quantity of money is rigidly fixed. Some people seem to infer that production and income can be increased by increasing the amount of money. But it’s like trying to gain weight by buying a bigger belt.
From Beyond the Grave, Keynes sends a powerful message to leaders today. If you want inflation to increase, Mr. Powell, you have to get people to spend. Announcing that you will allow prices to rise faster will not achieve this goal. And the increase in the money supply will not increase either, unless that money is given to people who are likely to spend it.
Jay Powell’s problem, and indeed the problem that all central bankers face, is that he can’t give people money directly. Only Congress has the power to do this. Until it intensifies and acts to improve the incomes of those at the lower or middle end of the income distribution, stable low inflation will remain a distant dream.
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