Higher inflation target could trigger jobs boom, say former Fed employees

WASHINGTON – The Federal Reserve may be grappling with an inflation problem, but two former senior U.S. central bank officials argue that further price increases in the future may be what’s needed to move the whole economy towards a higher plateau and generate a job boom that helps the most people.

David Wilcox, former Fed research director, and David Reifschneider, special adviser to former Federal Reserve Chairman Janet Yellen, argue in a new research paper that once the coronavirus pandemic has passed and the Fed is in In order to raise interest rates to more normal levels, it should then increase the national inflation target from 2% to 3% and use shock treatment of surprise rate cuts to achieve it.

“The unemployment rate could be on average 0.75 percentage point or more below its sustainable level in the first 15 years after the announcement of the higher target”, representing around 1.2 million people additional or more 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 is most tight come from marginalized groups,” they wrote, allowing higher inflation “could also help reduce racial and other inequalities” by maintaining people in their jobs longer and allowing them to gain more experience. and 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, support both, and are worth what they say would be “a sharp boom. of employment and production during the transition point end. “

The basic personal consumption expenditure price index, a measure of inflation closely watched by the Fed, reached 3.5% on an annual basis in June, triggering a debate at the central bank over the question of whether interest rate increases might be needed sooner than expected to control prices.

More flexibility

Wilcox and Reifschneider released their paper about a week before the U.S. central bank’s main annual research conference in Jackson Hole, Wyoming, a rally likely to include a broad discussion about the pandemic and the effectiveness of a new framework. the Fed’s monetary policy adopted just a year ago.

The debate over this new framework ruled out from the outset consideration of a higher inflation target, a politically sensitive idea that could run counter to the Fed’s mandated target of “stable prices”.

While the 2% target has been widely accepted as reasonable for keeping the economy away from the opposite evil of falling wages and prices – deflation – the Fed’s inability to push inflation through at the 2% level over the past decade led the central bank to announce that it would temporarily allow higher inflation “for a while” in order to reach its target on average.

Many leading economists have argued that the Fed should take the next step and raise the target permanently.

The 2% benchmark was set at a time when global interest rates were falling for a variety of reasons, leaving the Fed’s benchmark overnight interest rate closer to the “lower zero limit. “.

This left less room to cut interest rates to combat recessions and downturns, which made unconventional tools like bond buying a normal part of central bank toolkits. During the pandemic-fueled downturn, for example, the Fed not only cut its policy rate to near zero, but began buying $ 120 billion in long-term securities each month to keep costs down even lower. borrowing.

The standard argument for a higher inflation target is to let the Fed’s key rate rise as well and provide more flexibility to tackle any economic downturn through rate cuts alone.

Wilcox and Reifschneider make a different point: Even announcing the higher target, if paired with actions like lowering rates to achieve it, would have lasting economic benefits.

They note that the new Fed executive has promised a review after five years, a point at which, according to the two, “the current surge in inflation will have long since subsided and the unemployment rate will already be a little below its sustainable level “. and can be further lowered by another policy change.

“Many researchers have noted that if central banks increase their inflation targets – individually or in concert – they could do a better job in the long run of keeping inflation close to target and the workforce fully employed. “, wrote Wilcox and Reifschneider.

×

Related stories