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The Federal Reserve needs someone who understands inflation

By in Press Enterprise on October 26, 2017

By Tate Lacey

A worrying trend has developed among Federal Reserve officials in the past month: They claim to no longer have a working theory of inflation in the economy. This began at the September FOMC press conference when Fed Chair Janet Yellen admitted, “The shortfall of inflation from 2 percent … is more of a mystery.” This is problematic.

It absolves the Fed from achieving one of their goals mandated by Congress. Furthermore, a central bank that is both charged with managing inflation and admits that inflation is a mystery has the potential to lead to damaging policy decisions. As the president considers a successor for Yellen, he should ensure the nominee possesses a complete understanding of inflation dynamics and how the Fed can and cannot affect them.

Maintaining stable prices — keeping inflation manageable — is part of the Fed’s mandate. And in January 2012 the Fed explicitly announced a 2 percent symmetric inflation target saying it “is most consistent over the longer run with the Federal Reserve’s statutory mandate.” Since then, however, the Fed has consistently undershot that target.

The reasons for this undershooting have changed, but the Fed’s performance has not. First, the Fed argued inflation was low due to temporary factors that the central bank felt would not materially affect the longer run. Then the Fed offered more exotic explanations, citing lower cost wireless plans and decreasing prescription drug prices, as forces holding down inflationary pressures. Yellen has also discussed the so-called “Amazon effect” in which the growing share of online shopping holds inflation low.

The Fed technically could change this by injecting more money into the economy, allowing that money to circulate and raise inflation. Basic monetary economics says that the monopoly supplier of currency is capable of generating nearly any amount of inflation.

But excess money creation is dangerous. In the […]    

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