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Home Publications Blogs Beat the Press Is the Fed Committed to Keeping Inflation Below 2.0 Percent?

Is the Fed Committed to Keeping Inflation Below 2.0 Percent?

Thursday, 08 May 2014 05:00

In its coverage of Fed Chair Janet Yellen's testimony before the Joint Economic Committee, the NYT told readers:

"Ms. Yellen, in a similar exchange with Representative Richard Hanna, a New York Republican, strongly defended the Fed’s commitment to control inflation. She said the high inflation of the 1970s had been a formative experience for the entirety of the Fed’s leadership, and they were determined to keep inflation below the 2 percent annual pace the Fed has described as its target."

This statement implies that the Yellen is treating 2.0 inflation as a ceiling rather than an average. If so, this would be a marked departure from past statements of Fed policy and imply a considerably more hawkish stance of the Fed toward inflation. With inflation running below 2.0 percent for the last five years the Fed could allow the inflation rate to rise above 2.0 percent for a period of time and still maintain a 2.0 percent average.

If the Fed now views 2.0 percent inflation as a ceiling, it means that it would have to act earlier and more strongly to slow economic growth and prevent the unemployment rate from falling. The implication would be that many more workers would remain unemployed or underemployed and that tens of millions would have less bargaining power to boost their wages. This Fed policy would be helping to foster the upward redistribution of income we have been seeing over the last three decades.

Comments (11)Add Comment
2% Ceiling Also Increases Risk of Liquidity Trap
written by Robert Salzberg, May 08, 2014 5:30
The main power of the Fed is to raise or lower interest rates to either fight inflation or stimulate growth. The Fed has been faced with a liquidity trap for roughly half a decade and counting. Faced with a Congress that is now and will likely remain opposed to increasing spending, the Fed can't do much to stimulate the economy because of the zero lower bound.

If the Fed has now decided that 2% is a ceiling not an average, they have effectively de-fanged themselves and doomed America to anemic growth.

I don't think we should call it secular stagnation when Congress can act, but won't and the Fed is saying its policy is to pull away the punch bowl at any real hint of wage growth/inflation that could begin to reverse the decades long trend of wage stagnation.

written by Kat, May 08, 2014 6:16
High inflation. That was 40 years ago. Time for a new formative experience.
Yellen is yellow when faced with slightly above target inflation
written by Robert Salzberg, May 08, 2014 6:20
From Yellen's prepared remarks in February:

" In addition, the Committee has said since December 2012 that it expects the current low target range for the federal funds rate to be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation is projected to be no more than a half percentage point above our 2 percent longer-run goal, and longer-term inflation expectations remain well anchored. Crossing one of these thresholds will not automatically prompt an increase in the federal funds rate, but will instead indicate only that it had become appropriate for the Committee to consider whether the broader economic outlook would justify such an increase. In December of last year and again this January, the Committee said that its current expectation–based on its assessment of a broad range of measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments–is that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the 2 percent goal. I am committed to achieving both parts of our dual mandate: helping the economy return to full employment and returning inflation to 2 percent while ensuring that it does not run persistently above or below that level."


The economy has persistently run below both the 2% inflation target and above the 6-1/2 percent unemployment target so the Fed has consistently not met its mandate for over 5 years. Central bankers seem to be infected with an obsession with maintaining low inflation all the time as opposed to on average. If 2-1/2 percent projected inflation serves as a trigger, does anyone really believe the Fed won't cave to pressure if inflation actually hits 3%?
What, No Punchbowl?
written by Larry Signor, May 08, 2014 8:57
The Greenspan ideology will never die.
written by Dryly 41, May 08, 2014 9:32
The 1970's inflation was caused by Richard Nixon's imposition of wage and price controls in August 1971 when he feared the Fed would take away the punch bowel and jeopardize his re-election. He had abandoned the "incomes policy" of the Kennedy/Johnson administrations and inflation had creeped up. After imposing the controls he pressurized the weak and feckless Fed Chair Arthur Burns, who he had appointed, to inflate the money supply. It worked. Inflation was low and employment high, and, Nixon was re-elected where he sered until August 1974. When the wage and price controls were lifted after serving their purpose accelerating inflation ensued. They even had to coin a new word for it: "stagflation", meaning recession and inflation at the same time. This was quite and accomplishment never seen before, or, fortunately, not since.

I have never understood how this inflation became such a force in policy making that, like the McCarthyite searches for communists under every bed in the 1950's, people are searching for it everywhere. Even less do I understand how the giants of economics, Paul Samuelson, Robert Solow, James Tobin, and, even John Maynard Keynes were blamed for Nixons machinations, among others he took, to ensure his re-election. That was politics not ecomomics.

When I learned my economics, I learned that inflation was caused by two thing. One was "demand- pull" inflation caused by too many dollars chasing too few goods. It's a little difficult to discern such a condition at the present time as wages for middle income workers have been stagnant for 35 years; 8.7 million people lost their jobs and paychecks after the financial collapse in September, 2008 which decreased aggregate demand; there was a significant overhang of debt causing people to deleverage decreasing aggrigate demand; and, as Piketty and Saez have reported an astounding 93% of the increase in income from 2009-2012 went to the top 1$ of earners.

A second cause is "cost-push" inflation caused by wages rising significaltly in excess of the increase in productivity. Suffice it to say there is no evidence of this.

It may be that hyperinflation is just around the corner but there is no evidence of it.
Model of runaway inflation
written by jonny bakho, May 08, 2014 9:55
The Fed preference for 2% inflation reflects the preference of our Malefactors of Great Wealth for Cheap Labor and low wage inflation. Fear of runaway inflation is a red herring that is used to smackdown any attempt by labor to get a more equitable share of the economic output.

Deflation and inflation are a continuum. There are many reasons why wage deflation pressure is bad: #1 is high unemployment. Inflation that is too low is only marginally less bad than deflation. Too low inflation pressures relative wages to reset downward. A higher inflation rate is needed to let relative prices reset after a large shock such as we have just had. When inflation is discussed, the chorus of "Zimbabwe!!" drowns out rational discussion of problems created by inflation that is too low.

There are very few examples of runaway inflation. Therefore multiple models will fit the data, so It is difficult to extract the most important factors. There is no firm evidence that a 4% or a 6% inflation rate is any more likely to lead to runaway inflation than 2%. Models that rely on shocks and loss of confidence in a currency could drive runaway inflation from 2% as easily as 6%.
written by sherparick, May 08, 2014 10:06
I expect looking back on it it will be seen that Chairperson Yellen's statement about increasing interest rates about 6 months after ending the bond buying program will be seen a true "gaffe" e.g speaking a truth at the wrong time. Currently U2 has fallen to 6.3%. If the economy adds jobs at 150,000 a month clip, and if the participation rate does not pick up, then assuming the same trend in U2 over the last year, it will have fallen to 5.6+or-.2 by April 2015. http://data.bls.gov/timeseries/LNS14000000. Even if inflation is still below 2% I think the Fed will start raising interest rates at that point to get to what it calculates will be the correct "Taylor Rule" level as quickly as possible, which would be a nominal rate of 4% if U2 NAIRU is conceived of as 5.5% and inflation is approach 2%. Since the bond buying program appears likely to end by October this year, April 2015, six months afterward, is likely the date the Fed moves off the zero bound. Since the Fed is likely underestimating the deflationary winds of globalized labor, technological substitution, and concentration of wealth and income, this will likely be to soon and to much.
written by MacCruiskeen, May 08, 2014 10:25
"The Greenspan ideology will never die."

Not really--you might recall that Greenspan wanted to force the inflation rate down to zero-and it was Janet Yellen who convinced him that wasn't a good idea.
written by PeonInChief, May 08, 2014 10:51
Gee, the Fed policy serves the interests of the, to use an old-fashioned word, bourgeoisie. Duh!
high inflation of the 1970s had been a formative experience for the Fed’s leadership
written by Paul Mathis, May 08, 2014 10:55
High inflation of the 1970s was caused by the Arab Oil Embargo and Iranian Revolution, not by anything the Fed or Congress did. Interest rates were much higher -- double today's rates -- throughout the 1970s and federal budget deficits were low -- averaging 3% of GDP.

Does Yellen not know this history? She was an adult throughout this period and should be well aware that oil prices increased 10 fold in less than a decade. How would she have handled the oil embargo differently? She seems completely clueless about the 70s.
written by djb, May 08, 2014 2:08

I couldnt find where she said that

the aggressively arrogant and totally ignorant of economics congressman may have said that but i didnt see where she did

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.