Inflation policy, 2022: Background

Abstract

Abstract. By mid-2022, if not earlier, it was clear that the Federal Reserve’s inflation policy had failed. Not only did the Fed not focus on broad monetary aggregates (M2, M3, etc.), it also was not responsive to changes in end variables –an accelerating CPI indicator or Nominal GDP (NGDP). The Fed’s failing here reflects neglect by many non-Fed economists – eg, Krugman – of the same factors. The Fed has fitfully introduced average inflation targeting (AIT) over the last few years, which allows some flexibility depending on other economic variables, hence some counter-cyclicality in its methodology; it is a step toward NGDP targeting. But here too, the Powell Fed seemed not to notice cautionary signals.  By early 2022, however, monetary indicators had turned flat–just as the Powell Fed accelerated rate increases. Similarly, the dollar was rising against most other currencies, more presumptive evidence that US monetary policy is now contractionary. If we consider normal lag times, the Fed is likely to be over-doing it, so that an unnecessary recession may be in the works for 2023 or early 2024. One argument says that US pandemic and other spending in 2020 contributed to the inflationary surge in late 2021 and 2022. That is not likely: the world’s demand for treasury securities is quite robust. The US central bank does not need to monetize debt, which is the channel through which deficit spending would become inflationary. The Fed policy of paying interest on excess reserves (IOER) contributed to deflationary results during the decade following the 2008-2009 recession, a consequence of which was zero-bound interest rates. IOER, combined with the Fed’s policy of quantitative easing, resulted in a greater public sector role in resource allocation.

Keywords. John Maynard Keynes; Milton Friedman; Stephen Hanke; Broad money targeting; Nominal GDP (NGDP) targeting; Average inflation targeting (AIT); Foreign exchange rate targeting; Jerome Powell; Matthew Klein and Michael Pettis; George Selgin; Scott Sumner; Modern Monetary Theory; Interest on Excess reserves (IOER) policy; Zero-bound interest rates.

JEL. E00; E32; E52; E58; F21; F32.