The Federal reserve may be working to solve the inflation problem. Still, two former senior U.S. central bank officials believe that higher prices in the future may be needed to bring the entire economy to another high and generate prosperity that helps jobs.
Former Fed research director David Wilcox and former Fed Chairman Janet Yellen’s special adviser David Reif Schneider argued in a new research paper that once the coronavirus pandemic passes, the Fed can Interest rates are raised to more normal levels. Then, you should increase the national inflation target from 2% to 3% and use the shock treatment of unexpected interest rate cuts to achieve it.
“The unemployment rate could average 0.75 percentage point or more below its sustainable level during the first 15 years after the higher target is announced,” representing about 1.2 million or more additional people employed each year, the two economists, now with the Peterson Institute for International Economics, estimated.
“To the extent that people drawn into the labor market when it has tightest come from marginalized groups,” they wrote, allowing higher inflation “could also help reduce racial and other inequities” by keeping people in jobs longer and allowing them to get more experience and on the job training.
The risks – of financial bubbles due to loose credit or a possible recession triggered by rate hikes to combat a spike in inflation – are manageable, the two contend, and worth what they say would be “a marked boom in employment and output; during the transition period.”
The basic personal consumption expenditure (PCE) price index for measuring inflation, which the Fed closely monitors, reached 3.5% in June, sparking a debate about the central bank’s need to raise interest rates earlier control prices than expected.
Wilcox and Reifschneider published their papers about a week before the U.S. Central Bank’s annual major research conference in Jackson Hole, Wyoming, which may include extensive discussions on the pandemic and the effectiveness of the newly adopted Fed’s new monetary policy framework a year ago.
The debate on this new framework ruled out the consideration of higher inflation targets from the beginning. This is a politically sensitive idea that may run counter to the Fed’s goal of “stabilizing prices.”
Although the 2% target is widely regarded as reasonable and can keep the economy away from the opposite evils of wage and price decline, deflation, etc., the Fed has been unable to push the inflation rate to 2% in the past decade, prompting the central bank to announce will temporarily allow the higher inflation rate to reach its average target “in a period of time.”
This leaves less room for interest rate cuts in response to economic recession and economic slowdown, resulting in unconventional tools such as bond purchases becoming a normal part of the central bank’s toolkit. For example, during the economic recession caused by the pandemic, the Fed reduced the policy interest rate to close to zero and began to purchase $120 billion in long-term securities every month to reduce borrowing costs further.
The standard argument favoring a higher inflation target allows the Fed’s policy interest rate to rise and provide greater flexibility to respond to any economic slowdown by cutting interest rates alone.
Wilcox and Reifschneider put forward different arguments: the act of declaring a higher goal, if combined with actions such as interest rate cuts to achieve it, will produce lasting economic benefits.
They note that the Fed’s new framework promised a review after five years, a point at which, the two argue, “the current surge of inflation will have long since subsided, and the unemployment rate will already be a little below its sustainable level,” and able to be lowered further by another policy shift.
“Many researchers have noted that if central banks raised their inflation targets – either individually or in concert – they could do a better job in the long run of keeping inflation near its target and the workforce fully employed,” Wilcox and Reifschneider wrote.