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”.
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)