Introduction to Inflation and the Fed
The Federal Reserve, also known as the Fed, has been dealing with inflation rates above its target for 54 straight months. This is a significant issue, as the Fed’s primary goal is to maintain maximum employment and price stability. The Fed’s inflation target is 2 percent over the longer run, measured by the annual change in the Personal Consumption Expenditures (PCE) price index.
The Fed’s Inflation Target
The Fed uses a Flexible Average Inflation Targeting (FAIT) framework, which allows inflation to temporarily deviate from the 2% target as long as it averages 2% over time. However, the current situation has led some to question the effectiveness of this approach. With inflation remaining above target for an extended period, there are concerns that the Fed may need to adjust its strategy.
Janet Yellen’s Comments on Inflation
Former Fed Chair Janet Yellen has made comments on the importance of achieving the Fed’s inflation target. In a 2017 interview with CNBC, Yellen called the Fed’s failure to lift inflation to 2% her "single disappointment" and "only regret" as Fed Chair. She emphasized the need to ensure that inflation does not "chronically undershoot" the Fed’s objective. More recently, Yellen has acknowledged that stimulus spending may have contributed to inflation, but attributed the majority of the price spike to pandemic-related supply issues.
The Illusion of Precision
The Fed has been discussing new "inflation target ranges" rather than a fixed target of 2.0 percent. This approach has been suggested by some Fed officials, including Atlanta Fed President Raphael Bostic. Bostic has proposed a range of 1.75% to 2.25% as a potential alternative to the current target. This would allow for more flexibility in the Fed’s approach to inflation, rather than trying to hit a precise target.
The Fundamental Problem
The fundamental problem is that the Fed is clueless about inflation. The Fed only looks at poor measures of consumer inflation, while ignoring obvious asset bubbles. This has led to a situation where the Fed is slow to hike interest rates and fast to cut them, which can exacerbate inflationary pressures. The Fed’s measures of inflation, such as the CPI and PCE, do not accurately reflect the experiences of consumers. For example, the BLS has the percentages of people eating out versus at home reversed, and does not factor in tip inflation at all.
Consumer Inflation vs Inflation
The Fed does not count things related to home ownership, such as housing prices, property taxes, and homeowner’s insurance, as "consumer inflation". This is because the Fed considers homes to be a capital expense, not a consumer expense. However, this distinction is not meaningful to consumers, who experience inflation in all aspects of their lives, not just in consumer goods.
The Bank of International Settlements (BIS) Deflation Study
The BIS has conducted a historical study on deflation, which found that routine price deflation is not a problem. In fact, the study suggested that deflation can actually boost output by increasing real incomes and wealth. This challenges the conventional wisdom that deflation is always a bad thing.
Asset Bubble Deflation
However, it’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results, which can have severe consequences for the economy. The Fed’s attempts to defeat routine consumer price deflation have fueled the build-up of unproductive debt and asset bubbles, which eventually collapse.
Conclusion
In conclusion, the Fed’s handling of inflation has been problematic. The Fed’s inflation target has been exceeded for 54 straight months, and the Fed’s measures of inflation do not accurately reflect the experiences of consumers. The Fed’s approach to inflation has been too focused on consumer goods, and has ignored obvious asset bubbles. A new approach is needed, one that takes into account the complexities of inflation and the experiences of consumers. The Fed should consider a more flexible approach to inflation, such as a range rather than a fixed target, and should prioritize the measurement of inflation in all its forms, not just consumer goods. Ultimately, the Fed’s goal should be to promote maximum employment and price stability, not just to hit a precise inflation target.
