Dr. Seuss declares in “Horton Hatches the Egg”: “I meant what I said, and I said what I meant, an elephant’s faithful 100%.”
Likewise, Federal Reserve Chairman Jerome Powell was 100% true to the central bank’s new policy framework in 2021-2022 of waiting to raise interest rates until the economy reached full employment.
Powell gritted his teeth and let the Consumer Price Index (CPI) soar to over 8.5% — the highest in four decades — holding his fire for 13 months. The Fed finally relented in March 2022 with an increase in the federal funds rate of a thin 25 basis points.
Now the shoe is on the other foot.
The stock and bond markets jumped Dec. 13 after the government released its November CPI report. The annual advance in the core rate slowed to 6% from 6.3%. But note that core inflation is stubborn at 6%.
The Fed shifts gears
The Fed has now raised rates strongly, featuring a string of 75-point increases. Still, the fed funds rate remains below the CPI headline and core rates, as well as below the Personal Consumption Expenditures Price Index’s (PCE) headline and core inflation rates. (The Fed tends to focus more on the PCE numbers.)
So now, with economic growth showing resilience, and inflation acting stubborn, we have a number of economists and market commentators arguing that the Fed’s 2% inflation target is arbitrary and should be discarded or ignored. The Fed is being painted into a corner, critics argue, to either “sacrifice the economy” to hit its inflation target or to jettison that target to gain flexibility.
So will Powell defend the Fed’s pursuit of inflation control with the same zeal as he pursued its full-employment pledge?
This is getting interesting. Note that the Fed makes a rate decision Dec. 14.
Does the Fed’s 2% target have standing?
For those arguing that 2% does not have a deterministic standing and is arbitrary, let me point out that “full employment” is at least an equally squishy concept. Yet the Fed hung in there, allowing its inflation target to go to pot because it crafted a very bad policy framework statement, adopted in the wake of its Fed “listens tour.”
Maybe that tour should have focused more on “Fed thinking” and “remembering” its own monetary policy lessons? But no, “the Fed listens” tour saw a lot of political pressure heaped upon the central bank. The Fed clearly let its guard down.
Why the Fed’s target makes sense
The Fed’s 2% target may not be enshrined in economic theory, but it can be well-defended. 1. It was the target and pledge made by the Fed in 2012 when it shifted to inflation targeting. 2. Among Western central banks that have inflation targets, every one of them has a 2% target. 3. Changing this target could have substantial negative ramifications for Fed credibility. 4. While there is no number that can be defined as price stability (except maybe zero), the point of the target is to limit and contain inflation.
With a 2% target, inflation will double prices every 35 years — or about twice in your lifetime. With a 3% target, inflation will double prices every 23 years, three times in your lifetime. At 4%, prices double every 17.5 years, and so on.
It is hard to consider a target number higher than 2% as representing “price stability.” I do not find 2% to be as arbitrary and potentially changeable as many of critics do unless they mean to give up the goal of price stability as well. And if they mean to do that, what is the point of having a central bank?
And there are further complications
There is also the issue of symmetry as the Fed paid huge costs to keep its word when it restrained from hiking rates and being responsive to inflation, let alone preemptive, as inflation soared in 2021. But apart from credibility, policy symmetry and hitting its target, there is also the issue of what to do down the line as inflation remains stubborn — well above 2%, the economy slows, and the unemployment rate rises. Then what is the Fed supposed to do? What does its “newish” policy framework statement direct it to do? That is not at all clear.
The Fed is behind the eight-ball
What we have here is a Fed-made mess. The very second that the Fed jettisoned the old Volcker/Greenspan framework that argued the Fed did all it could for maximum employment by delivering price stability, the Fed opened a can of worms — and they are still wriggling and will continue to wriggle until the Fed chooses a new policy framework. The Fed simply can’t be expected to stabilize inflation and minimize unemployment (attain full employment) at the same time with the paltry tools it has — let alone pursue additional objectives. The Fed’s agreement to undertake this version of the dual mandate represented a very bad economic decision and the abandonment of decades of learning about monetary policy leaving the Fed behind the eight-ball.
What the Fed should do
All I can offer on this subject is this: Congress can heap whatever goals it wishes on the Fed. The central bank exists because of an act of Congress, so Congress, in the end, controls the Fed.
But if Congress gives the Fed an impossible task, that does not mean the Fed can do it. The Fed is the central bank. And whatever bells and whistles are hung on its branches, the central bank is principally and always responsible for the inflation rate. If the Fed needs to choose among goals, it should choose to tame inflation first and foremost.
If Congress is unhappy with that, it can change the Fed’s mandate to make it more specific — then Congress can take the political heat for doing so. Under no circumstance should the Fed make an inflation-perpetuating decision to service other objectives that may have been placed on its plate.
At some point the Fed must know what its identity is and must be willing at least to force Congress to strong-arm it to do wrong if that is what is going to happen. The Fed should not choose to take an easy-money, inflation-stirring fork in the road to appease a bad and vaguely written policy mandate. The Fed needs to know what to prioritize. So far it has failed that test.
Robert Brusca is chief economist of FAO Economics.