Should the Fed Declare Victory on Inflation? The Case For a 3%, Not 2%, Fed Target

Should the Fed Declare Victory on Inflation? The Case For a 3%, Not 2%, Fed Target

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Paul Krugman and Mohamed A. El-Erian recently raised an interesting question: Should the Fed shift its goal from 2% to 3%, and declare victory over inflation? It may sound farfetched, but these notable names have begun a debate in the finance world that by pressing on to their 2% inflation goal, the Fed will have to inflict more financial pain on consumers and businesses than it’s worth. Brace yourself, we broke out the thesaurus for this one.

The Inflation Conundrum

In the hallowed corridors of fiscal policy, a seismic shift is quietly rumbling, with the venerable 2% inflation target of the Federal Reserve finding itself under the scrutinizing gaze of a formidable coalition. A collective of economists, industry analysts, and influential finance magnates are steadily coalescing around a novel notion: a 3% inflation bull’s-eye for the Fed. In this nuanced ballet of numbers and policy, the equilibrium is tilting, ushering in a fresh chapter in the age-old saga of monetary strategy. But will the outcry from notable names like Paul Krugman and Mohamed A. El-Erian be enough to push Powell?

Source: Wall St. Journal

Mohamed El-Erian: Live With Slightly Higher Inflation, but Without a Recession

As the Fed steadfastly clings to its hawkish disposition, inflation, though receding from the summits of 2022, remains resolutely above the hallowed 2% mark. This predicament has sown the seeds of dissent, with an escalating chorus calling for recalibration. Enter: the advocates of a 3% threshold, a realm where inflation can roam a tad more freely, without jostling the economic fabric unduly. This cohort argues that the machinations necessary to painstakingly eke out a 2% inflation are akin to using a sledgehammer to drive a thumbtack, inflicting unnecessary discomfort on the broader economic edifice. Mohamed A. El-Erian recently pitched this scenario in an interview with Marketplace:

“Imagine that you are at a stable 3% inflation rate. And the choices you have are the following: One is go to 2% and risk tipping the economy into recession or alternatively live with 3% and avoid a recession. That’s the sorts of things that the Fed is going to be forced to think about towards the tail end of this year. And it’s going to be tested, and it’s not an easy decision. But I think that if the Fed was able and willing to swallow its pride, it would probably opt for the first option, which is better for the economy: Live with a slightly higher inflation rate, but don’t dip the economy into recession.”

Tom Barkin: If We Change the Target, We Lose Credibility

However, in the echelons of the Federal Reserve, defiance reigns. Fed Chair Jerome Powell and his cadre of officials contend that shifting the goalposts is a Pandora’s box best left unopened. Richmond Fed President Tom Barkin bluntly underscores the importance of credibility, stating, 

“If you were to unilaterally declare that you’re not going to hit the target that you’ve set, then you are also declaring that you’re less credible in any target you set.” 

A veritable quagmire, where the cost of adjustment could rival the benefits of the shift.

Paul Krugman: How Many People Should Lose Their Jobs for a Mistake?

Amidst this intellectual tempest, a heavyweight luminary, Harvard’s Paul Krugman, emerges. As inflation remains stubbornly north of the 2% benchmark, Krugman and fellow economists have lent their voices to the swelling tide advocating for a new norm – a 3% inflation target. Krugman’s endorsement stems from a belief that time has bestowed on the 2% rationale a veneer of obsolescence.

In a cerebral tête-à-tête, Krugman dovetails with Jason Furman, a Harvard University professor, who trumpets the clarion call for a 3% inflation trajectory. Furman’s argument, elegantly woven in a recent Wall Street Journal op-ed, posits that a departure from the 2% straitjacket, ceremoniously introduced in 2012, might just be the shock absorber that the economy craves in the face of seismic recessions. The thesis holds that during economic stagnations, allowing inflation to flirt with 3% could be a prudent hedge against widespread job losses, a poignant salve for the labor market’s tribulations. Summarizing his argument, Krugman rhetorically asked,

“How many people should lose their jobs for a mistake?”

Yet, this paradigm shift isn’t devoid of trepidations. Critics contend that this proposed transition to a 3% haven might cast a shadow of uncertainty over the value of a dollar, entangling the populace in an intricate web of future calculations. The metaphoric Rubicon, once crossed, reveals an enigmatic terrain of uncharted waters.

To traverse this transformative terrain unscathed, the Federal Reserve faces a twin mandate. It must elucidate that a higher inflation target isn’t a mere escape route from the clutches of lowering inflation but a strategic maneuver to fortify the financial landscape. Moreover, consistency in adhering to the new target is paramount, preventing policy vacillation.

In the crucible of differing viewpoints, Krugman’s stance stands as a beacon, radiating skepticism. While aligned with the concept of a 3% target, Krugman diverges from Furman’s assertion that the most arduous leg of the journey lies ahead. Armed with statistics, Krugman accentuates that underlying inflation measures currently gravitate around the 3% axis, raising the pertinent question: 

If 3% aligns with the economic pulse, why not declare victory now?

A rhetorical sally that unveils the human toll exacted by adhering dogmatically to policies that may lag behind a swiftly evolving landscape.

The Debate Rages On

As the debate whirls, tangible reverberations emerge. The canvas of a higher inflation target could grant the Federal Reserve leeway to tinker with interest rates, orchestrating a symphony that resonates through sectors far and wide. Companies, including the iconic Tesla, have echoed the sentiment, attributing sluggish demand to heightened interest rates, potentially fanning the flames of pricing upheaval and bottom-line ripples.

In this arena of cerebral combat, where digits and policy intertwine, the tug-of-war between 2% and 3% inflation targets encapsulates the delicate tango central banks must master. On one hand, many consumers believe that goods and services are still pretty inflated right now. On the other hand, the public has a historic lack of confidence in this particular Fed staff, with many believing that the U.S. is on its way to a recession. The evolving chorus of economists, finance moguls like Mohamed A. El-Erian, and luminaries like Krugman underscores the ever-fluctuating cadence of economic theory, as the Fed seeks to balance the scales between prosperity and stability. In this theater of intellectual discourse, the future trajectory of the Fed’s inflation target dances on the cusp of uncertainty, an enigma shrouded in a captivating allure. 

One thing is for certain: With Jackson Hole less than one week away, if Powell were to signal that he’s open to the idea of the Fed raising its target inflation from 2% to 3%, the stock market would be in for one hell of a rally.

But let’s be real — he probably won’t.

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