Too Much Inflation? Just Raise The Inflation Target!

The target interest rate was quickly returned to 0.25 percent, and additional asset purchases resumed at breakneck speed, with the Fed’s portfolio soon topping eight trillion dollars.

But doves nonetheless felt the Fed had been too aggressive against price inflation, and the covid crisis gave doves an opportunity to press their case. In August of 2020, the Fed adopted a new policy in which it would pursue an “average” two-percent inflation goal. In other words, the Fed could now pursue a price-inflation goal above two percent for some periods so long as it all averaged out to two percent over time.

But even that hasn’t been enough for the advocates of ever more price inflation, as we now see in calls for ending the two-percent target altogether. The catalyst for this is the fact price inflation has been repeatedly creeping upward.

The Fed now admits that inflation has again surged, with expectations of an inflation rate exceeding four percent at year’s end. (This is CPI inflation, of course, not the much-larger asset-price inflation which the Fed studiously ignores.)

Presumably, the longer inflation persists above the target rate, the more the Fed will feel pressure to bring inflation back down through some sort of tapering. After all, the adoption of a two-percent target implies two percent is the "correct" inflation rate. Anything higher than that is presumably "too much." But the last thing the doves want is any concerted effort to get price inflation down right now. Many suspect today’s weak economy can’t handle even a little bit of tapering. 

For example, writing at the Wall Street Journal earlier this month, Greg Ip noted that Powell appears to be banking on the inflation rate soon returning to two percent. But what if it doesn’t? Ip says if inflation remains above targets, the Fed should just raise the targets. He writes:

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