The Fed’s longer-run goals: Defining success down?
Yesterday, the Federal Reserve released a statement regarding its “longer-run goals and monetary policy strategy.” What seemed to the biggest news for most covering the release was the Fed’s identification of an explicit inflation target: 2 percent annualized growth in the personal consumption expenditures’ price index (oddly, they don’t specify just the “core” price index that removes more volatile items – not sure why).
This is pretty big news – and pretty bad news. While they leave themselves plenty of wiggle room to go above this target during particular circumstances, the economy could benefit greatly from an inflation target substantially above this 2 percent for the next several years, and it’s hard to see how yesterday’s statement makes this much easier. One could argue that by establishing a “long-run target” of 2 percent, the Fed could then justify shorter-term inflation targets above this level to make up for particularly disinflationary periods (like, say, the past four years), but again, the statement was pretty explicit about the 2 percent long-run target and not explicit at all about going above this in the near-term.
Bigger news, perhaps, was the statement’s identification of the “longer-run normal rate of unemployment” as being between 5.2 and 6 percent. This was always going to be the danger of a deep, drawn-out recession – policymakers will be tempted to declare “mission accomplished” well before unemployment has reached pre-recession levels (5 percent in Dec. 2007, 4.6 percent for the annual average of 2007), let alone before reaching levels that actually sparked widespread (and non-inflationary) wage-growth (the 4.1 percent average for 1999 and 2000, for example).
This is an old story – policymakers, particularly at the Fed, have for much of the past 30 years preemptively moved against higher rates of inflation by slowing the economy as unemployment has reached predetermined “longer-run normal” rates (the exact jargon and acronym for this magical rate that the economy allegedly cannot go below without sparking runaway inflation varies). Through much of the 1980s and early 1990s, economists more concerned with lower rates of unemployment than battling incipient inflation (sometimes called “inflation doves,” though I prefer “unemployment hawks”) argued that the Fed should at least test the limits of lower unemployment before short-circuiting recovery. And the late 1990s expansion proved them right – unemployment fell far below the contemporaneous estimates of the “longer-run normal rate” and yet inflation failed to accelerate.
Failing to heed this lesson and declaring that the best possible outcome that can be reached is an unemployment rate up to 1.5 percent higher (translating to three million extra unemployed workers) than what prevailed in the year before the Great Recession hit will just constitute one more severe casualty of this episode.