Scott Sumner  

In monetary policy, 8k peaks are easier to climb than 7k peaks

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For several years I've been gradually pulling my hair out as I read one pundit/commenter after another claim that since the Fed is currently struggling to hit its 2% inflation target, there's no point in setting a higher inflation target. That assertion is demonstrably false---and it's not even debatable.

Now it seems this madness has even infected the Federal Reserve. James Alexander directed me to a new post by Minneapolis Fed President Neel Kashkari:

However, there are significant downside risks with these policy recommendations that I believe must be carefully considered before being adopted. First, the Federal Reserve is struggling to hit its current target of 2 percent and has come up short for four years. Market forecasts and expectations about our ability to hit 2 percent have fallen. If we announced a new higher target, it isn't clear why anyone would believe that we could hit it. The Federal Reserve's credibility could be weakened. To say it another way: Had Japan announced a higher inflation target a decade ago, would it have made much difference? I doubt it, because Japan too faces nonmonetary challenges.
Can we bring back Kocherlakota? I need to take a deep breath and regain my composure. Here are the facts:

1. For several years the Fed has been tightening monetary policy. This started with tapering, then with signals of an increase in interest rates, then an actual increase in interest on reserves. Now Fed officials are signaling that more rate increases are likely to occur. The Fed does this for one reason, and one reason only, to prevent overshooting of their target. If they were in fact "struggling" to hit their inflation target, it's not clear how they would respond. But one thing that is 100% clear is that if they were truly "struggling", THEY WOULD NOT BE RAISING THEIR FED FUNDS TARGET INTEREST RATE. This is a really basic point, which is taught in every single EC101 textbook. The Fed raises rates to prevent high inflation, not when it is struggling to achieve it. If you don't believe me, look at the monetary policy chapter of any recent econ text. No central bank that is raising rates is also struggling to hit its inflation target. They may be failing to hit it (I agree with that claim) but they are not "struggling" to hit it. By analogy, a car driving north from LA on I-5 is not struggling to reach San Diego; they are failing to reach San Diego.

2. A higher inflation target would not be harder to hit than a lower target, it would be easier to hit, especially if it were a level target. The reason is simple. The higher the inflation target, the more room the Fed has to cut rates, and achieve their target through conventional means. In monetary policy, it's easier to climb an 8000-meter mountain than 7000-meter peak. Your intuition from everyday life does not apply in the realm of monetary theory; it's an Alice in Wonderland World, where nothing is at it seems.

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3. The Japanese did in fact raise their inflation target in early 2013, and moved from mild deflation to mild inflation.

PS. Just to be clear, I do not favor a higher inflation target. My claim is that the "struggle to hit 2%" argument is completely wrong.

PPS. I seem to recall that K2 (pictured) is harder to climb than Everest. Is that right? K2 is certainly a more magnificent specimen, and more deserving of the honor "world's tallest peak", at least on aesthetic grounds.


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COMMENTS (17 to date)
AntiSchiff writes:

Kashkari isn't qualified to be a Fed president. He's a mechanical engineer. As an institution, the Fed is fundamentally broken.

Daniel Kahn writes:

Maybe you should try talking to these wayward Fed officials. I bet you could get an audience considering the cachet you've achieved in the last few years. Kashkari is not an economist, so maybe he would be open to some continuing education that's pertinent to his new job as one of the most important economic policymakers in the country. But he's probably just a banking industry stooge.

John Hall writes:

Fewer people have climbed K2 than Everest and of those who try there is a greater likelihood of dying in the process.

But, K2 is an 8k peak.

Dennis writes:

You've convinced me of almost everything here, but I'm going to disagree with you that a higher inflation target is easier to hit than a lower one because there is more room to cut rates, at least in the present near zero rate scenario. If rates were "normal", and presumably higher in the higher inflation scenario, I would agree. And while a higher inflation target now would overall help the economy, it would probably be harder to hit in that the inflation hawks would be even more afraid of overshooting. Instead of "targeting" 2% inflation and delivering 1.5%, a 3% target might only deliver 2% due to even greater timidity. In that very narrow sense Kashkari is right, but otherwise of course you are right. Those who say the Fed can't deliver additional inflation either deny the existence of Venezuela or deny the existence of the Intermediate Value Theorem.

William writes:

People think that a higher inflation target requires "concrete steps" and since the Fed and others have done followed some of these "concrete steps" to no avail, people think that simply talking of a higher inflation target won't work.

bill writes:

I'm amazed that you're able to keep your composure at all. Thanks for the continued great posting.

ThaomasH writes:

I think that Kashkari is narrowly right; a higher target if the Fed continued to act as it has -- stopping QE, raising rates, and talking about raising them further before even a 2% trend in the price level is restored -- it would further damage its credibility.

Of course he is incorrect in saying that the Fed has or is struggling to hit its inflation target for the "north is not south" argument you advance.

William writes:

People think that a higher inflation target requires "concrete steps" and since the Fed and others have done followed some of these "concrete steps" to no avail, people think that simply talking of a higher inflation target won't work.

Scott Sumner writes:

Daniel, I doubt that Fed officials have any interest in what I have to say.

Thaomas, If they had a higher inflation target, then they obviously would not keep acting the way they have. When Japan raised its inflation target, it did not keep acting the way it had.

Willam, Yes, that's a common mistake.

bill writes:

We should ask Neel and anyone else, "how hard is it to end IOR? Writing a statement and stop sending money to banks that are holding reserves is a struggle?"
It's not even slightly difficult like raising the inflation target or using level targeting or making a futures market. We're literally asking them to do LESS.

Philo writes:

Kashkari illegitimately uses modal terms. He talks about "[m]arket forecasts and expectations about our ability to hit 2 percent"; but the market is predicting whether the target will be hit, not whether the Fed has the ability to hit it. Again: "If we announced a new higher target, it isn't clear why anyone would believe that we could hit it." What the market cares about is not whether you could hit it, but whether you will hit it.

Benjamin Cole writes:

Excellent blogging.

The globe's major central banks appear to want to miss their ITs on the low side, or even wallow in deflation.

I think this is because of the overwhelming premise in many circles that fiat-money central banks are prone to inflation. The track record of the last 35 years suggests the opposite.

Market Monetarists need to spread a new cabal theory that left-wingers are behind tight money. The lefties know tight money will lead to deflation, slow growth, and very low borrowing costs for the state, which can then borrow money and create jobs, even while paying down debts with QE.

James Alexander writes:

Scott
Isn't it also fair to say that missing a 4% target by 1% is a lot better for nominal growth than missing a 2% target by 1%.

Obviously, it's best to not miss any target, by having an symmetrical LT.

Philo writes:

@ James Alexander:

I think Kashkari assumes that if the Fed had a 4% target it would miss it by 3%!

That would damage the Fed's credibility; but the Fed has so little credibility to begin with--who cares?

Jose Romeu Robazzi writes:

If the FED wanted to achieve the 2% target we wouldn't have to discuss a 4% target ...

James Alexander writes:

UK's BoE shows the way to go ...
https://thefaintofheart.wordpress.com/2016/09/14/uk-monetary-policy-revolution/

HL writes:

Hi, Scott. I think you will get a real kick out of an amazing speech by Jason Cummins at PIIE.

https://www.youtube.com/watch?v=k7W_yiRlvGM&list=PL_x8a0z7Y1m581ddWIVtysuN44u3NjJBg&index=1

Main speech
33:00~58:30

Q&A
1:29:50~1:34:13
1:39:10~1:41:53

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