Too Much Inflation? Just Raise The Inflation Target!

In late August, Fed Chairman Jerome Powell suggested that the Federal Reserve would begin tapering before the end of the year admit an admission that price inflation was rising above the two-percent target. Nonetheless, the Fed took no immediate action in the following month. This week, Powell again suggested a taper would begin soon, stating it would begin soon enough that the process could “conclud[e] around the middle of next year,” and maybe could begin in November. This, of course, was highly conditional, with Powell noting this taper would only happen if “the economic recovery remains on track.”

Some interpreted this as a hawkish turn for Powell, but again, we should expect no immediate action on this. Lackluster economic growth remains a concern and Powell's qualifier on the “recovery” remaining on track will be key. Last week, Goldman downgraded the US economic growth forecast, and the Beige Book—which always casts economic growth in a rosy glow—also reduced its description of the economy during July and August to ”moderate.” Meanwhile, the Bank of England today signaled a worsening global situation with its own downgrade of growth expectations. In other words, if the economy isn’t improving enough—according to the Fed—then it can simply abandon plans to taper.

In other words, we may be looking at a repeat of the decade following the Great Recession. Growth was remarkably slow in those days in spite of immense amounts of monetary stimulus.  The Fed repeatedly spoke of an “improving economy,” however, and repeatedly hinted at tapering. It was only in 2016 when the Fed dared to allow the target interest rate to inch upward. This was largely done out of fear the Fed would have no room to maneuver in case of another crisis, however, and not in response to inflation, which remained low in the official measures.

But in 2017 and 2018, when CPI inflation began to push above two percent, the expectation arose that the Fed would finally begin to meaningfully taper to keep target inflation near the state two-percent target. This alarmed some inflation doves who were concerned—with good reason—that any reining in of the Fed’s easy-money policies would end the very fragile and lackluster recovery then underway. The repo crisis of 2019 was the first sign of trouble in the Fed’s very-minor tapering effort. But any other brewing liquidity crises were soon obscured by the covid crisis and the economic collapse that followed.

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