What if the Headline CPI Rose 5.5% Over the Next 15 Nonths?

In that case, the Fed would have fallen short of its 2% inflation goal over the past 5 years.  That’s right, if the CPI rose by a total of 5.5% (an annual rate of 4.1%) over the next 15 months, the CPI would still have risen by less than 2% per year between July 2008 and July 2013.   (April 2012 is the latest reading, that’s why I say 15 months.)

That means that even if we were to have an extraordinary burst of inflation over the next 15 months, monetary policy over the past 5 years would have been too tight even if the Fed didn’t give a damn about the millions of unemployed.  It would have failed to hit its explicit 2% inflation goal over the past 5 years.  Something for the Fed to think about at its June meeting.

How can that be?  Simple, inflation has average 1.22% over the past 45 months.  That’s headline inflation; I’m not tricking you by excluding food and energy.  Why do I start at July 2008?  Because that’s when NGDP started plunging fast, and unemployment starting rising fast.  And the Fed does in fact have a dual mandate.  One can debate exactly what the dual mandate means, but here’s something we can be 100% sure it does not mean.  It can’t mean that the Fed should always act as if it had a simple 2% inflation mandate, with no concern for jobs.  That would clearly violate the law.

Some might argue; “But that low inflation is in the past, the Fed has to look to the future.”  OK, but TIPS spreads show less than 1% inflation over the next 2 years.

Sometimes when I read my fellow economists I simply can’t imagine where they are coming from.  They seem so uninterested in monetary policy.  Where’s the outrage?  Are they just apathetic, or are the ignorant of the data?

Let me make the point even more forcefully.  If the unemployment rate were currently 5.6%, instead of the current 8.2%, I could easily walk into the next FOMC meeting and demand easier money, based on the inflation data alone.  That’s because if we were at the Fed’s definition of the natural rate (5.6%), then monetary policy decisions would hinge on one factor, and one factor only—inflation.  I’d walk into the meeting and say:

  1. Inflation averaged 1.22% over the past 45 months
  2. The markets expect that to fall further to less than 1% over the next few years, based on current policy.
  3. That means it’s a slam dunk for further easing. There is no conceivable argument that even the fiercest Fed hawk could use in opposition.

And that’s if unemployment was 5.6%, but it’s actually 8.2%!!  Are people completely crazy, or am I the one who is missing something?

Yes, I know that this isn’t how things work in the real world.  We have very complete minutes from the Riksbank meetings, and each time Lars Svensson comes in and very clearly explains what the board has to do to meet their legal mandate.  And each time they totally ignore him.  It’s basically a response of; “Facts? We don’t base our decisions on facts; we go with our gut instinct.”

Just thinking about the irrationality of monetary policy makes my blood boil.

Keep telling everyone you know the following:

Even if the Fed drove the CPI up 5.5% over the next 15 months, inflation would have averaged below 2% over the past 5 years.  Policy would have been too tight even if the Fed didn’t care at all about the unemployed.

See what the inflation hawks say in response.

Bernanke says the Fed would cut rates right now if it could.  That means Bernanke agrees with me that money is too tight.  So don’t just sit there, do something else please.

PS.  The previous 5 years (before July 2008) inflation averaged 3.6%.  And how did the Fed react to that high inflation, which occurred when unemployment was really low?  They cut rates sharply in late 2007 and early 2008, despite less than 5% unemployment.  And does anyone recall any Congressmen other than Ron Paul bashing the Fed back then?  Seriously, is they any respectable argument for the hawkish position right now?  An argument that isn’t transparently political?  I sincerely want to know.

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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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