Is the Fed Committed to Keeping Inflation Below 2.0 Percent?

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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.