Via Economic Policy Journal

Federal Reserve Board monetary policy meeting

Bloomberg columnist Tim Duy, who is close to Fed Governor Lael Brainard, is out with a new piece where he reports that the Federal Reserve Bank is about to shift policy and allow inflation to “run hot.” 

“Faced now with the prospect of another prolonged period of low inflation, Fed officials are signaling they will place less emphasis on Phillips curve estimates when setting policy,” he writes.

He then tells us Brainard said this week that “with inflation exhibiting low sensitivity to labor market tightness, policy should not preemptively withdraw support based on a historically steeper Phillips curve that is not currently in evidence.”

He went on (my highlight):

No longer are estimates of longer-run unemployment taken as almost certainly indicating the economy is at full employment. Instead, Brainard said the Fed should focus on achieving “employment outcomes with the kind of breadth and depth that were only achieved late in the previous recovery.” The Fed is going to try to run the economy hot to push down unemployment.

By de-emphasizing the Philips curve, the Fed loses its primary inflation forecasting tool. Instead of an inflation forecast, the Fed will rely on actual inflation outcomes to determine the appropriate time to change policy. Brainard pointed out that “research suggests that refraining from liftoff until inflation reaches 2% could lead to some modest temporary overshooting, which would help offset the previous underperformance.” 

This is type of goose-inflation policy action is the equivalent of the early 20th-century medical practice of prescribing smoking to treat asthma.

As former Fed chairman Paul Volcker pointed out in his memoir, Keeping At It: The Quest for Sound Money and Good Government, concerning the 2% price inflation target:

I puzzle at the rationale. A 2 percent target, or limit, was not in my textbook years ago. I know of no theoretical justification.

But Fed thinking has gone beyond this curious target thinking and now allows for higher inflation to “balance out” periods of lower inflation.

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With a likely major jump in price inflation around the corner because of the mad printing of trillions of dollars during the COVID-19 panic, the last thing we need is a Fed willing to allow price inflation to run hot. The hotter the price inflation gets, the more difficult it will be to bring it under control. Three-percent inflation is very likely, possibly 5%, but I can’t rule out 10% or 13% if the Fed really screws things up given their fatuous thinking about inflation and their over-confidence on how easy it will be to get price inflation under control once it starts to climb at a serious pace.

Hug your gold coins.

RW