The FOMC issued an opaque statement yesterday observing that the economy is continuing to expand at “a moderate pace,” though unemployment remains too high while inflation is falling. The statement attributes the weakness of the recovery, at least in part, to fiscal tightening, perhaps suggesting that the Fed would not, under these circumstances, tighten monetary policy if fiscal policy were eased.
Information received since the Federal Open Market Committee met in March suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown some improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.
Notice despite the neutral, matter-of-fact tone of the statement, there are two factually inaccurate, or at least misleading, assertions about inflation. First, while the assertion “inflation has been running somewhat below the Committee’s longer-run objective,” is not objectively false, the assertion ignores the steady downward trend in inflation for the past year, while sewing confusion with a gratuitous diversionary reference to “temporary variations that largely reflect fluctuations in energy prices.” By almost any measure, inflation is now running closer to 1% than to the Fed’s own 2% target.
Second, the statement asserts that longer-term inflation expectations have remained stable. Oh really? If we take the 10-year TIPS spread as a proxy for long-term inflation expectations, inflation expectations have been falling steadily since the mid-January to mid-March time frame, when the breakeven rate fluctuated in a narrow range between 2.5% and 2.6%, to a spread of 2.3% yesterday, the lowest since early September of last year.
The FOMC continues:
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee continues to see downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2% objective.
Well, here is my question. If the FOMC “seeks to foster maximum employment and price stability,” and the FOMC itself anticipates that inflation over the medium term will likely be less than 2%, why, under the FOMC’s own definition of price stability as 2% inflation, is the FOMC proposing to do nothing — not a single wretched thing — to hit its own inflation target?
Under both elements of its dual mandate, the FOMC is unambiguously obligated to increase the rate of monetary accommodation now being provided. The FOMC asserts that unemployment is elevated; it also asserts, notwithstanding a pathetic attempt to disguise that obvious fact, that inflation is below its target. Both conditions require increased monetary expansion. There is now no trade-off between inflation and unemployment, and no conflict between the Fed’s two mandates. So why can’t the Fed do what it is plainly obligated to do by current legislation? Pointing a finger at the President and Congress cannot absolve the Fed of its own legal obligation not to tolerate an inflation rate below that consistent with price stability when unemployment is elevated. Is there no one capable of extracting from the Chairman of the Federal Reserve Board an explanation of this dereliction of duty?
Interestingly enough, I happened to catch a piece (“Should we bring inflation back from the dead?”) on American Public Radio’s “Marketplace” last evening. After asking David Blanchflower of Dartmouth College and Kevin Jacques of Baldwin Wallace University about the potential benefits of moderate inflation in the current environment, reporter David Gura turned to Marvin Goodfriend, formerly of the Richmond Fed, and now at Carnegie-Mellon, for a contrary view. Here is how Goodfriend explained why more inflation would not be a good thing.
Of course, resurrecting inflation is not risk-free. Economist Marvin Goodfriend says this kind of thinking could lead the economy to overheat: “If a little inflation is good, maybe a little more inflation is better.” It is something that is hard to control.
Goodfriend tells his students at Carnegie Mellon University to remember something.
“Inflation doesn’t die,” he says. “It’s like a vampire.”
You can vanquish it with “determined policy,” Goodfriend explains. Inflation will creep back into its coffin. And then, when you least expect it, it can come back with a vengeance.
Whew! Talk about sophisticated economic analysis. But then again, Goodfriend’s students at Carnegie-Mellon are super bright, aren’t they? Could this be what Bernanke and his colleagues are thinking? The vampire theory of inflation? Say it ain’t so, Ben.