Not even the Fed makes sense when “talking inflation”!

It’s one of the big questions hanging over the U.S. economy: Why is inflation so subdued?

Prices and wages been have sluggish since the 2007-2009 recession, and especially so in the past couple of years. There are signs inflation could tick up soon, but it remains low. It undershot the Federal Reserve’s 2% target for the 23rd consecutive month in March according to the central bank’s preferred measure, the personal consumption expenditures price index.

Economists at the Cleveland Fed have a theory. The current bout of low inflation is the product of multiple factors including slow economic growth, slack in the labor market and “unexpected, temporary events that are specific to inflation,” wrote Edward S. Knotek IIand Todd E. Clark in an essay accompanying the regional bank’s annual report.

Let´s leave aside headline inflation, subject to temporary spikes due to things like oil shocks, and attention to which can cause grave harm (remember 2008?).

“Too low” inflation is the direct result of “too low” NGDP growth (and growth expectations) which is a consequence of “too low” broad money growth and low velocity growth.

How do you change that? Certainly not by promising to keep interest rates low “forever” because that only indicates nominal spending growth is expected to be low “forever” and so will broad money growth and “high” money demand (low velocity growth) remain in place “forever”. So inflation will also remain “too low” “forever”.

Pictures:

Why inflation subdued

To change people´s expectations about the future change the monetary policy regime. Stop talking AND targeting inflation and target what matters for growth and employment: Nominal spending (NGDP – Level targeting)

One thought on “Not even the Fed makes sense when “talking inflation”!

  1. The title of the Cleveland Fed paper?

    Inflation: WHY IT IS VERY LOW, AND WHY IT MATTERS.

    Maybe someday, the Fed or a Fed branch will actually publish a paper entitled, “Economic Growth: Why It is Very Low, and Why It Matters”.

    The inflation obsession continues. It is always the first topic at every Fed gathering or meeting or paper, and always the last topic too. And this was one of the better papers!

    BTW, the Cleveland Fed paper predicts that the PCE will get back to the 2 percent average inflation target in 2016-7 or so. That’s just the average target, not above it. If the 2 percent PCE inflation figure really was an average target, I guess the Fed would have to run at 3 percent or so for several years.

    Ha-ha.

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