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The precise level of inflation the Federal Reserve should target is less critical for the U.S. economy than making sure prices rise in a slow and predictable manner, several experts said on Tuesday.
“We know there is a lot wrong with high inflation. And we know there is a lot wrong with variable inflation. There is clear and empirical evidence on that,” said professor Charles Calomiris, an expert on financial institutions at Columbia Business School.
“We know there is not much wrong with low, steady inflation.”
The Fed adopted an informal 2% inflation goal in 2012 in the wake of the Great Recession, but some former central bankers in the U.S. and abroad contend a higher target would be better for the economy.
The Fed modified its strategy in 2021 by saying it would seek an average 2% inflation rate in the long run. The move was instigated by an unusually long period of low inflation in which prices rose well below 2% a year.
The debate over the Fed’s inflation target has flared up again as the central bank battles the worst outbreak in 40 years. The latest bout of inflation was triggered by disruptions in the global economy tied to the coronavirus pandemic.
The annual rate of U.S. inflation using the consumer price index surged to as high as 9.1% last summer before slowing to 7.1% by the end of 2022.
To get inflation back under control, the Fed has jacked up a key short-term U.S. interest rate to a top end of 4.5% from near zero last spring. The central bank is expected to keep raising rates — already at a 15-year high — to above 5%.
Supporters of a higher inflation target argue it would give the Fed more flexibility in managing the economy. They suggest central banks should raise their goal to 3% or even 4%.
Central banks would not need to raise interest rates quite as aggressively, they say, and potentially induce a recession. And a higher inflation target would allow them to cut interest rates even more to help stimulate the economy when it became weak instead of resorting to more exotic measures such as bond buying.
Former St. Louis Fed President Thomas Hoenig, a longtime critic of the Fed’s monetary strategy, said the 2% inflation goal became popular among central banks in recent decades despite a lack of research explaining what was optimal target.
Yet he also said he didn’t think raising the target would be better for the economy, especially after the most recent change in 2021. Why would anyone trust the Fed to keep inflation low, he said, if it keeps changing its target.
“At that point the Fed goal should be to maintain stable prices,” said Hoenig, who prefers the central bank aim for 2% inflation or less.
Calomiris was open to a higher inflation target, but he cautioned that there are few examples in modern history of countries maintaining stable 4% inflation and experiencing steady economic growth. When inflation gets that higher, he said, it tends to drift even higher.
Hoenig and Calomiris spoke at a even held by the conservative-leaning American Enterprise Institute.
