The Federal Reserve’s 2 percent target rate for consumer inflation is coming under scrutiny from economists, lawmakers and investors, who are all expressing doubts not only about whether 2 percent inflation is desirable in the post-pandemic economy but if it’s even possible.
“I doubt that the [Federal Reserve] alone can get us below about 4 percent,” Senate Banking Committee member Thom Tillis (R-N.C.) said Wednesday. “And so then the question is, what can we do or what can the administration do from a regulatory standpoint that will take the edge off?”
“I don’t think structurally it can be done purely through set-it-and-forget-it with some number that is approaching 5 percent at the end of the day,” he said, referring to the Fed’s projected interest rate level for 2023, which was revised upward to 5.1 percent as the Fed hiked rates by another 50 basis points on Wednesday.
Senate Commerce and Transportation Committee member Roger Wicker (R-Miss.) described 2 percent target inflation as “not realistic.”
“It’s likely to be much higher,” he said Thursday.
Wall Street bigwigs are making similar statements, arguing that 2 percent inflation is not worth the pain of the recession that it would take to get there.
“I don’t think the Federal Reserve can get inflation back to 2 percent without a deep, job-destroying recession. Even if it gets back to 2 percent, it won’t remain stable there for the long term. Accepting [plus or minus] 3 percent inflation is a better strategy for a strong economy and job growth over the [long term],” hedge fund manager Bill Ackman wrote online on Wednesday.
“The Federal Reserve 2 percent inflation target is no longer credible. De-globalization, the transition to alternative energy, the need to pay workers more, lower-risk, shorter supply chains are all inflationary. The Fed cannot change its target now, but will likely do so in the future,” he added.
The possibility of a new acceptable inflation level is something the Fed should be open to, Rep. Raúl Grijalva (D-Ariz.) said Thursday, adding that this was a subject he’d been discussing with colleagues.
“I think for a period of time [it’s] a new normal,” Grijalva said. “Two percent should be the goal, but according ourselves some flexibility and some breathing room [wouldn’t be] a mistake.”
Fed Chairman Jerome Powell dismissed the notion of accepting anything above 2 percent as a consumer inflation rate during his press conference Wednesday.
“Changing our inflation goal is just something we’re not thinking about, and it’s something we’re not going to think about,” he said. “We have a 2 percent inflation goal, and we’ll use our tools to get inflation back to 2 percent. I think this isn’t the time to be thinking about that.”
However, Powell vacillated slightly on the point while speaking to reporters.
“There may be a longer-run project at some point,” he said before quickly adding, “We’re not going to consider that under any circumstances.”
Economist Joseph Stiglitz said he perceived feelings of guilt in the Fed’s steadfast interest rate hike over beginning its quantitative tightening program too late.
“The central bankers have said, ‘Oh, we got behind the ball in not addressing inflation’ when in fact it wasn’t their fault. It was a supply-side inflation, not a demand-side inflation,” Stiglitz said during an event hosted by the Roosevelt Institute on Thursday. “I don’t want to put it as a psychiatrist, but they’re feeling guilty and they’re feeling that they have to show their resolve, show their masculinity and act strongly.”
The reason some economists believe the Fed won’t be able to lower prices simply with interest rate hikes is that the current inflation has more to do with the profit levels of large businesses than wage costs.
Interest rate hikes make it more expensive to buy things, which slows down economic activity and encourages companies to fire workers. This lowers their overhead so they can still turn a profit while charging less for their products.
But if prices are higher simply because companies have been able to demand more money from customers due to an increase in their power over markets and a change in what consumers will tolerate, this logic doesn’t hold.
That’s the situation that an increasing number of economists say the economy is in now.
“US unit labor cost numbers [show] non-financial corporate profits growing faster than labor costs. In fact, profits have [grown] faster than labor costs for seven of the past eight quarters, as prices have [grown] faster than labor costs for seven of the past eight quarters. Today’s inflation is more about margin expansion than labor costs,” UBS economist Paul Donovan wrote in a note to investors last week.
“What has been clear is that there has been a large increase in markups,” Stiglitz said Thursday. “We don’t know eventually whether those markups will come down.”
Stiglitz said that 2 percent as an acceptable inflation level has no basis in economic theory but has simply become a conventional standard.
“Not only is there no magic in 2 percent, there’s no magic in the timespan to get back to 2 percent. So even if you believe in 2 percent as a magic formula, there is nothing to say we have to get back to 2 percent in one year or four years.”
Tillis said on Wednesday that prices could eventually come back down to 2 percent inflation of their own accord.
“It may ultimately organically do it,” he said.