Monday, January 16, 2023

Fed's Inflation Target Too Low

 Financial FAQs


Why is the Federal Reserve enforcing a 2 percent inflation rate target? Such a monetary policy has meant Fed Governors have endangered economic growth by holding to a target rate that I believe is too low.

Whatever the basis for their fears of inflation—whether it be that so-called inflation expectations are too high, or product costs (such as worker’s wages) rise too fast, the result of their credit[-tightening measures has been that household incomes have been kept lower than inflation historically, increasing income and wealth inequality.

It has thus denied workers earning hourly wages as shown in the above FRED graph (gray bars inflation) the chance to ever catch up to historical inflation and better their financial well-being.

But shouldn’t the prime goal of a well-functioning Democracy be to decrease income inequality? Especially when there are so many American voters—especially high-school educated wage earners--questioning whether American-style democracy is serving their needs.

Former Chairman Ben Bernanke said in 2012 keeping a 2 percent cap enabled the Federal Reserve to better balance its twin mandates to maintain stable prices with maximum employment.

Why? It seems 2 percent is a common target throughout advanced economies, rather than based on empirical studies that verified it in fact maintained stable inflation and maximum employment, the Fed’s twin mandates.

Economists will tell you the 2 percent figure is based on their belief that the measured inflation rate overshoots actual inflation by something like 2 percent, which means they were really trying to get back to zero inflation! If so, that sounds like a great way to tempt actual deflation and a serious recession.


This is what happened in the Great Recession that lasted from 2007-09. The Fed had jacked up their fed funds overnight rate charged to banks to 5 percent. It was when Fed Chair Alan Greenspan killed the housing market by the Chinese drip torture method, raising the fed funds rate by one-quarter percent 16 consecutive times, thus busting the housing bubble and causing the Great Recession (after Greenspan suggested that an adjustable-rate mortgage might be desirable in such times).

Greenspan’s Federal Reserve busted the housing bubble and inflation for sure. CPI inflation dropped to 0 percent by 2015, and EU countries such as Denmark had to offer negative interest rates on home mortgages to revive their housing market. This meant that a mortgage lender had to literally subsidize the mortgage borrower to induce them to take out a mortgage loan.

Household incomes suffered even more during this time. Average hourly wages didn’t begin to increase until 2015 and inflation return to its longer-term 2 percent range in 2017 when new Fed Chair Ben Bernanke began the Fed’s policy of buying treasury and mortgage securities to inject liquidity back into the markets to stimulate growth. (He was nicknamed ‘helicopter Ben’ for the huge boost it gave to the money supply).

This is but one example of what happened when the Fed clamped down too hard on inflation. It has been the Fed’s bias since the 1970s that resulted in keeping household income from ever catching up to inflation.

Progressive labor economist Jared Bernstein opined on this matter in the Washington Post shortly after Bernanke announced the Fed’s decision.

“The fact is that the target is 2 percent because the target is 2 percent. Were the target 3 percent or 4 percent, you’d be reasonably asking me, why 3 or 4? To the extent that there’s an anti-inflation bias among economic elites (and thus an anti-full-employment bias), and I think that’s often the case, I’d reiterate arguments I made here…that the debates over full employment and Federal Reserve policy are generally dominated by the interests of the minority who worry more about inflation and asset values than those who worry about jobs and paychecks.”

It has in fact become a tool to suppress the incomes of average households and worsen income inequality; just as hourly wages are accelerating. But will that change their minds?

Harlan Green © 2023

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