What About Inflation?

I find Binyamin Applelbaum’s Fed preview to be rather depressing and distressing.  Applelbaum begins with a solid insight – reducing the unemployment rate is not the same as maximizing employment:

The Federal Reserve is making modest progress in its push to reduce the unemployment rate. But that is not the jobs goal Congress actually established for the Fed. The central bank is supposed to be maximizing employment. And on that front, it is not making progress.

Applelbaum points to the employment to population ratio as evidence that the Fed is falling short of the mandate.  But are Fed officials ready to do more? No:

There is little sign, however, that Fed officials are considering an expansion of their four-year-old stimulus campaign as the Fed’s policy-making committee prepares to convene Tuesday and Wednesday in Washington.

Applelbaum notes that the recent flow of data has forced monetary policymakers to back away from talk of ending large scale assets purchases.  But among the reasons to avoid expansion of the program we find this:

Another reason the Fed is not embracing new measures is that it already has tied the duration of low interest rates to the unemployment rate. The Fed said in December that it intended to hold interest rates near zero at least as long as the unemployment rate remained above 6.5 percent, provided that inflation remained under control. The theory is that the economy will get as much stimulus as it needs.

But what if the inflation rate is persistently below the target?  Or, worse, trending lower?  Clearly then the economy is not getting the stimulus it needs.  If we are missing on both targets, then the economy needs more stimulus.  And while we can debate the efficacy of monetary policy in influencing the pace of employment growth, surely monetary policy can influence the inflation rate.  Correct?

The distressing part of this article is that it reads as if the Fed has given up not only on its ability to influence the pace of employment growth, but also on its ability to influence the inflation rate.  Or, possibly worse, that the Fed is simply no longer concerned with the inflation rate now that the obvious threat of deflation has passed.  This again feeds suspicion that the Fed’s 2 percent target is really an upper bound.

Bottom Line:  The Fed is supposed to have a dual mandate.  Dual, as in two.  Maximum employment and price stability.  One would think that failing at the latter would be at least as important as failing at the former.  Perhaps we are learning that the Evan’s rule is flawed – it should not be about only conditions before which the Fed considers removing stimulus, but also conditions by which the Fed deliberately considers adding additional stimulus. A two-side Evan’s rule is needed.

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