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Déjà-Vu All Over Again

I must say I'm puzzled and frustrated by the many clueless responses, like this one by Dallas Fed President Richard Fisher, to those well-placed (mostly Keynesian) economists who have been insisting for some time that, with the unemployment rate still above 7%, and the latest (annual) inflation rate at just 1%, what the U.S. economy needs right now is a higher inflation target. Instead of 2%, they say, make it 4%, or even 6%. Those higher targets, they explain, can be be counted on to raise interest rates, rescuing us from the zero lower interest rate bound we've been stuck near, and thereby getting the unemployment rate back down to the Fed's current goal of 6.5%, if not lower.

Should we take their advice? Heck, yeah! After all, this isn't the first time that we've been in a situation like the present one. There was at least one other occasion when the U.S. economy, having been humming along nicely with the inflation rate of 2% and an unemployment rate between 5% and 6%, slid into a recession. Eventually the unemployment rate was 7%, the inflation rate was only 1%, and the federal funds rate was within a percentage point of the zero lower bound. Fortunately for the American public, some well-placed (mostly Keynesian) economists came to the rescue, by arguing that the way to get unemployment back down was to aim for a higher inflation rate: a rate of about 4% a year, they figured, should suffice to get the unemployment rate down to 4%–a much lower rate than anyone dares to hope for today.

I'm puzzled and frustrated because, that time around, the Fed took the experts' advice and it worked like a charm. The federal funds rate quickly achieved lift-off (within a year it had risen almost 100 basis points, from 1.17% to 2.15%). Before you could say "investment multiplier" the inflation and unemployment numbers were improving steadily. Within a few years inflation had reached 4%, and unemployment had declined to 4%–just as those (mostly Keynesian) experts had predicted.

So why are these crazy inflation hawks trying to prevent us from resorting again to a policy that worked such wonders in the past? Do they just love seeing all those millions of workers without jobs? Or is it simply that they don't care about jobs at all, just so long as inflation is low? Whatever the reason, they certainly come across like a bunch of callous dunderheads.

Oh: I forgot to say what past recession I've been referring to. It was the recession of 1960-61. The desired numbers were achieved by 1967. I can't remember exactly what happened after that, though I'm sure it all went exactly as those clever theorists intended.

P.S.: I can already imagine Ken Rogoff's response to this post. Something to the effect, no doubt, of "This time is different."

P.P.S. (November 20): Of course it is different this time–but not, I submit, in ways that clearly favor the doves. One particular difference that comes to mind is that, whereas in the 60s policymakers (implicitly) gambled that an increase in the actual rate of inflation would not lead to a corresponding increase in the expected rate (and, hence, in the rate of upward or leftward movement of short run aggregate and labor supply schedules), those calling for a 4-6% inflation target today actually see it as a means for achieving a like increase in expected inflation, and so are (implicitly) gambling that such an increase in expected inflation will not result in any corresponding increase in the rate of upward or leftward movement of short-run aggregate and labor supply schedules.

I leave it to my readers to decide for themselves whether the new wager is more or less rash than the old one.

  • will.luther

    I think there are some interesting issues here concerning the relative merits of level and growth rate targets. Let me to explain briefly for those readers not familiar with the discussion. Growth rate targets let bygones be bygones. If you are targeting NGDP at 5% and come up short (say 4%) this period, you just reestablish your trajectory at 5% from the current period and move on. Level targets, in contrast, forces one to pay for past mistakes. If you are targeting NGDP at 5% and come up short (say 4%) this period, you must temporarily target NGDP at some rate greater than 5% in order to return to the original 5% growth path; once you are back on track, you return to the original 5% target.

    I think the level target has some important advantages. For one, it makes it much easier to predict the variable well into the future. Moreover, since prices are sticky, a quick response that restores the old trajectory precludes costly price and contract adjustments. If the response isn't so quick, and some of these adjustments have already been made, there might still be some merit in that it reaffirms the credibility of your target. You are effectively saying: yes, adhering to the rule is costly, but a deal is a deal. This could anchor expectations the next time around.

    At some point, though, we are so far removed from the old trajectory (i.e., the economy has already adjusted to the new trajectory) that it would be foolish to try to return to the original trajectory. So, how far away is too far to return? Or, to put it somewhat differently, how long do you have to consistently miss the level target before it is no longer worthwhile to return?

    I think we are past the point of return today: the best we can hope for (given the current regime) is a level target from here forward. But, two years ago, I probably would have said return to the old growth path of nominal income. I'm just not sure when it is reasonable to make this switch… and I am not even sure how we would know that it is reasonable to make the switch.

    (Of course, the Fed isn't following a rule. But the rules language might still be useful for establishing a benchmark against which we might judge actual policy. On the other hand, we might think that such rules tell the central bank what to do conditional on widespread understanding that they are going to follow the rule. If so, it might be an inappropriate rule in a world where no one expects the central bank to follow the rule…)

    • BillWoolsey

      I supposed a Volker/Reagan nominal recovery–10% nominal growth for a year–and then stabilizing to a new growth path. I support a 3% rater.

      But that would still leave the economy well below the Great Moderation Growth path.

      If, instead, we just commit to current growth path, which is more like 4.5%, then it is desirable to start calling for nominal (and real) wage cuts. Or, at the very least, no pay (cost of living) increases,) until nominal wages reach a lower growth path, proportional to the drop in the nominal GDP growth path.

      I am not proposing wage ceilings or anything, and don't think firms should cut wages or refraining from raising wages if the face of shortages of particular types of labor. But, I think it is the responsibility of economists, including free market ones, to explain this.

    • George Selgin

      I agree with all your points, Will. But I'm puzzled concerning how they bear on the issue addressed in the post, to wit, that concerning the merits of proposals for raising the inflation rate target.

      • will.luther

        Some of those calling for a higher inflation rate target today are doing so because we have undershot their ideal 2 to 2.5% target for several quarters. They are calling for a temporarily higher target rate to get back to the old growth path. I (and presumably you) think it is too late for that to do much good. They disagree. So I suppose the disagreement concerns how long is too long to return to the original growth path.

        (We might also disagree with them–and perhaps with each other, though I don't think that is the case–regarding what should be targeted, inflation or nominal GDP. But they could make a similar argument for increasing the nominal spending rate, since that variable is also below its historical growth path.)

      • George,

        You need to distinguish those wanting to raise the target and those who want a more expansionary policy in order to hit the existing target (such as Steve Hanke).

        • George Selgin

          My post refers only to those who have argued for a higher target, Warren. I suppose someone could read it as also objecting to any expansionary policy, but they'd be reading off the page in so doing.

          If fact, however (for the record), I oppose further expansion, whether to realize a higher inflation target or not; indeed I think QE3 a mistake we will have reason to regret. Whatever it may have contributed toward recovery (and I believe it hasn't contributed much at all, except to generate another, minor asset price boom), the price-tag–a ridiculously bloated Fed balance sheet, with all sorts of potential problems awaiting once recovery gets going and rates start rising–makes it a bum deal.

          Nor do I see any inconsistency between my stand and my agreement with those who think a rule for stabilizing NGDP would be a good thing. There's a world of difference, in my opinion, between the real consequences of having and adhering to such a rule, and those from the Fed's recent, expansionary policies, and that's true notwithstanding that NGDP remains, by some measures, below some pre-crisis trend. The political-economy of the ad-hoc expansion has, in my opinion, been too far removed from sound policy to make it defensible.

  • RussNelson


    • George Selgin

      You got it! For your prize, you have a choice between the stuffed puppy dog and the rubber duck.

  • RussNelson

    Oh good! It's almost too subtle. I'm sure that if I were an economist (mostly Keynesian) I wouldn't have gotten it. I'll take the rubber duck.

  • BillWoolsey

    I don't favor a higher trend inflation rate. I rather favor the opposite–a stable price level on average.

    However, I don't think the story of the sixties is best understood as a permanent increase in the inflation target.

    The target was for unemployment and real output.

    The theory is that we would have to tolerate more inflation to maintain full employment. As time passed, the amount of inflation it was "necessary" to tolerate was ratcheted up. And "incomes policy" had more and more to control that inflation.

    At the time, fiscal policy was considered primary. And so, the zero nominal bound was not a concern.

    When I consider my opponents on this issue, that is, those proposing higher trend inflation to keep average nominal interest rates higher, and so avoid the zero bound, I think it is obvious that they consider monetary policy primary, and obviously, favor a monetary policy based upon interest rate targeting. I believe that given this new inflation trend they favor, they will use Taylor-rule restrictions. In particular, if there appears to be an output gap, with production below potential and the unemployment rate above the natural rate, they would lower the relatively high nominal interest rate to raise spending on output. But if inflation rises above the higher target, then they raise interest rates back again to chock of the inflation. Any increase in inflation above target would be matched by real output below potential, according to the Taylor rule.

    It would be like what we had in the Great Moderation, but at a higher trend inflation rate.

    To me, it is like the debate we would have about whether growth in spending is best at 2%, 3%, 5%, 7%, which would tend to generate trend deflation of 1%, inflation of zero percent, 2% (as now,) or 4%.

    • George Selgin

      Bill, regarding your first point, allow me to repeat here what I remarked to Daniel Kuhn elsewhere, in response to his similar argument: "The understanding at the time (I mean the early 60s), informed by the Samuelson-Solow version of the Phillips Curve, implied a practical equivalence between employment and inflation targeting. By Volcker's time it was evident that there was no such equivalence."

  • VangelV

    Isn't everyone missing the point? The numbers being reported are fake. We have already seen a whistleblower admit that the BLS is making up data to keep driving the reported unemployment levels lower by assuming that many people are no longer looking for jobs. The same thing happens when the BLS reports inflation and GDP. So what we have is a discussion about make believe numbers that no rational person would trust.

    • George Selgin

      So, VangeIV, what are these conspirators thinking? Are they trying to make the numbers low to make the economy look better than it is? If so, why settle for 7.3%? Why not make the fake number 6.5%, since everyone keeps complaining that 7.3% is still lousy? (By the way, most economists I know have long been aware that the drop in U since the crash has mainly been a result of more workers getting out of the labor force, so I'm not sure anyone had to "blow the whistle" on that.)

      And if the BLS has been making fake, low inflation numbers, I suppose the Fed hasn't put the word out to it that it has a 2% target, which means that 1% actually makes the Fed look just as bad as 3% might.

      What the hell is the government coming too when the bureaucrats can't even get their lies straight?

      • VangelV

        Well, they are manipulating the reported unemployment, inflation, and GDP rates for political gain. They can't report 6.5% because nobody would believe them.

        For a smart guy you seem to have not learned very much. After the fraud in the securitization markets and the LIBOR scandal why would you not admit that the people that were called 'conspiracy nuts' were correct? Why is it that you can't see what is going on around you now and realize that the Fed is trapped? Have you noticed that the Fed's liquidity has created bubbles in the bond and stock markets? Or that all that easy money has papered over the next great bubble as the shale producers that are being hyped up as the next great thing have yet to generate positive cash flows or true economic profits? Haven't you noticed that the shale oil are using EURs that are twice what the actual production data is suggesting appropriate? Given the fact that the data is showing the Bakken ready to peak some time within the next year how is the US supposed to become energy independent when the producers that it was banking on have been unable to profit on the positive side of the production curve?

        When I look at some of you guys I wonder why it is that all that intellectual horsepower is so misused. Isn't it time you shed your bias and tried to examine the data objectively?

  • Justin Merrill


    I agree with you of course but let me play devil's advocate for a second. I can imagine an astute observer noticing that in the early '60s we were on the Bretton Woods standard. The Keynesians at the helm felt that lowering interest rates was the appropriate policy domestically, but that higher interest rates were needed to defend the dollar's gold convertibility internationally. The compromise was the first Operation Twist which sought to increase investment by lowering long term interest rates and make the dollar attractive by raising short term rates.

    So how would you counter the person arguing that the 60's policy was good, and it wasn't until the collapse of Bretton Woods and the exogenous oil shocks that the stagflation occurred. You see, it wasn't Arthur Burns's fault, it was those darn Arabs and OPEC. The Keynesian model wasn't flawed, it was just cost push inflation!

    • George Selgin

      How would I respond? Well, I'd remind that addlebrained Keynesian cretin that the collapse of Bretton Woods and, after it, OPEC (which was a reaction to the declining gold value of dollar-invoiced oil exports) were themselves consequences of the Fed's inflationary policies of the 60s.

      • Justin Merrill

        Makes sense to me. I'm no longer able to pretend I'm a Keynesian and counter with a thoughtful rebuttal at the moment. Either I play a poor Keynesian or your argument wins. I suspect both.

        The only thing I can think of is the possibility of the inflationary head fake; a credible commitment to be irresponsible, but then fail to deliver the expected inflation, which I guess is the Krugmanian way out of the liquidity trap and opposite of what happened in the 70's.

        • George Selgin

          I agree Justin that some of these proposals for raising the inflation target have a bait-and-switch flavor about them. But it is precisely such attempts to "trick" the public with monetary policy that ultimately tend to backfire.

  • Your Neighbourhood Economist

    One thing that I don't understand about inflation hawks is why concern yourself with trying to control something that is out of your control. Inflation no longer tends to be determined by the strength of the economy as may have been the case in the past but by the strength of the global economy. It is the narrow focus on inflation that paved the way for the global financial crisis – have not we got better things to worry about. For more on this argument, see

    • George Selgin

      I'm confused, Neighborhood: I'm not arguing for an inflation target, or for trying to "control" inflation, whereas the "doves" I'm criticizing are. In fact I've written at considerable length against policies aimed at maintaining a stable price level or inflation rate. If you are looking for a naive inflation hawk to bash, you've come to the wrong place!

    • Justin Merrill

      What George said, plus in your post you linked you mention that monetary policy should target unemployment instead of inflation, which is a terrible idea. There can be structural changes (like inflation, can also be imported) and in the long run monetary policy is impotent at controlling real variables but you get drifting expectations. Nominal anchors are better than real ones, which become buoys instead of anchors.

  • Your Neighbourhood Economist

    Sorry for getting the wrong end of the stick as per the intention of the blog posting. But I do stick by my ideas on inflation loosing its usefulness as a target for policy market. As well as being unrelated to the underlying health of the economy, it no longer seems to be relevant to the aver person on the street. I have a blog posting on that too if you are interested…

    • VangelV

      We should let the free markets do their job. That means no central bank bureaucrats making plans behind closed doors and no legal tender laws that make fiat money mandatory.