The Fed released the minutes of its recent meeting held on August 10, 2010. Here’s what they say, so far as domestic inflation is concerned:
Policymakers generally saw the inflation outlook as little changed. They observed that a range of measures continued to indicate subdued underlying inflation and that growth in wages and compensation remained quite moderate. Many said they expected underlying inflation to stay, for some time, below levels they judged most consistent with the dual mandate to promote maximum employment and price stability. Participants viewed the risk of deflation as quite small, but a number judged that the risk of further disinflation had increased somewhat despite the stability of longer-run inflation expectations. One noted that survey measures of longer-run inflation expectations had remained positive in Japan throughout that country’s bout of deflation. A few saw the continuation of exceptionally accommodative monetary policy in the United States as posing some upside risk to inflation expectations and actual inflation in the medium run. (my bold)
Get that? “Price stability” = “Inflation”. A bit Orwellian, wouldn’t you say? Inflation will remain below levels most consistent with price stability (ignore for the moment the other half of the mandate)? Inflation is, by definition, price instability. Logic is not, it seems, the life of a Federal Reserve Board member.
But what if they mean inflation is not high enough to maintain their dual mandate of maximum employment and price stability? In other words, what if they mean inflation needs to tick higher (but not too much higher) in order to maximize employment? Well, it is long past time they buried the Phillip’s curve tradeoff between employment, i.e., economic growth, and inflation. Have they all been asleep for the last forty years?
The seventies saw high inflation and high unemployment (remember the “misery index”). The eighties saw steadily decreasing inflation and unemployment (“It’s morning again in America”). The nineties saw continued disinflation (Fed-speak for a decreasing rate of inflation), and continued low unemployment, with a mild and temporary uptick in unemployment at the beginning of the decade. The aughts, until the financial system collapse, saw increasing inflation and stable unemployment.
Can we now abandon the idea that inflation causes unemployment rates to decline, and that disinflation, or deflation causes them to increase? If something doesn’t even consistently appear together, i.e., if there is no correlation, how could there possibly be causation? For there to be a causative relationship between A and B, it is imperative that A and B consistently appear together. Just because they appear together does not necessarily mean there is a causative relationship, but if they don’t appear together, causation can be ruled out.
The bias towards inflation, and the errant belief that a lack of price increases is conclusive evidence of a lack of inflation, are the flawed premises upon which the Federal Reserve’s monetary policy has rested since Alan Greenspan took the helm in 1987. And they are wrong.
It is just an unhappy accident of history that Greenspan happened to accede to the Fed chairmanship just as the Cold War was winding down and the country was about to enjoy the fruits of a peace dividend; technological advancements in information and communication, and American ascendancy to sole superpower status. No matter what bias towards inflation the Fed might have adopted, it was apt not to get in the way of growth, particularly in the nineties, that wished to occur. By the aughts, growth due to the peace dividend and technological advancements had about played out, but Greenspan’s inflationary bias coupled to America’s monetary hegemony with the international reserve currency kept up an illusion of growth through ultra-cheap money.
An inflationary bias posing as “price stability” is how we’ve arrived at this point. The only way out now is to quit tinkering with the money, and allow the markets to set prices in whichever direction they prefer.