Opening Statement (as Delivered): I digress from my job here to say that I agree with everything that Jason and Josh have said. They do not speak just for themselves. They speak for me as well.

And let me also digress by trumping both Jason and Josh.

They both said “if you thought a 2% inflation target was appropriate a decade ago”. A decade ago I did not think a 2% inflation target was appropriate.

It was twenty-five years ago this summer that Larry Summers and I went to the Federal Reserve’s conference at Jackson Hole to say, among other things, that we thought it would be extremely risky and inappropriate to drop the Fed’s informal inflation target from its then-five percent to two percent. The 1990 savings and loan crisis was a small macroeconomic shock. Yet the Federal Reserve cut short-term interest rates by 600 basis points to respond to it. If there were ever a big shock, we said, the Fed would want all that much room to maneuver and more. It would not have that room to maneuver with a two percent inflation target.

So I’ve been beating this drum for twenty-five years off and on, and feeling very Cassandra-like for the past decade.

Now on to my job here. It is to get all medieval, in the sense of Thomas Aquinas, on you. It is to deal with the objections to our position, and then to provide what we believe are sufficient answers to those objections.

I hear four arguments for not changing the 2%/year inflation target, even though pursuing that target found us in a situation where monetary policy was greatly hobbled in its ability to manage the economy for a solid decade. And, as best as I can evaluate them, all four of these arguments seem to me to be wrong. They are:

The Federal Reserve, even at the zero lower bound, has powerful tools sufficient to carry out its stabilization policy tasks (Cf.: Mankiw and Weinzierl (2011), so moving away from 2%/year as a target is not necessary. This leaves begging the questions of why, then, employment has been so low over the past decade and why production is still so low relative to our circa-2007 expectations.

The problem is not the 2%/year target but rather pressure on the Federal Reserve: pressure from substantial numbers of economists and politicians practicing bad economics and motivated partisan reasoning. (As an example, somebody sent me a video clip this week of the very smart Marvin Goodfriend half a decade ago, arguing that faster recovery required the Fed to hit the economy on the head with a brick to make people more confident in its willingness to fight inflation This ignores the Fed’s long institutional history of being willing to ignore outside pressure as it performs its standard monetary policy task of judging what appropriate interest rates are. Pressure only mattered when we got into “non-standard” monetary policies, which we needed to do only because the low inflation target had caused us to hit the zero lower bound.

At 2%/year, inflation is non-salient: nobody worries about it. A higher inflation rate would bring shifting expectations of inflation back into the mix, distract people and firms from their proper task of calculating real costs and benefits to worry about monetary policy, and make monetary policy management more complicated. But right now people and firms are “distracted” by the high likelihood of depressions that last longer than five years. That is a much bigger distraction than worrying about whether inflation will be 4%/year of 5%/year. And right now the zero lower bound makes monetary policy management much more complicated than it was back in the 1990s when the impact of Fed policy on inflation expectations was in the mix.

The Federal Reserve needs to maintain its credibility, and if it were to even once change the target inflation rate, its commitment to any target inflation rate would have no credibility. But the credibility you want to have is credibility that you will follow appropriate policies to successfully stabilize the economy—not credibility that you will mindlessly pursue a destructive policy because you think it somehow wrong to acknowledge that the considerations that led you to adopt it in the first place were wrong or have changed. As my friend Daniel Davies puts it in his One-Minute MBA Course: “Is a credible reputation as an idiot a kind of credibility really worth having?”

Over to you, Joe…

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Answers to Questions: There is no unemployment rate target right now.

The Federal Reserve thinks about what the non-accelerating inflation rate of unemployment might be. But they claim not to have any strong view. They claim to be guided by the data, in terms of assessing how much pressure the economy can take. By contrast, the Federal Reserve had an informal inflation target of four to five percent per year in the late 1980s and early 1990s. And it then shifted down first, in the mid-1990s, to an informal target of two percent per year for the core PCE index under Alan Greenspan. It then formalized that under Bernanke in the late 2000. If they did have an unemployment rate target to talk about, we would be talking about that as well. But they don’t.

The question is a very good one. When I come write the economic history of the 2010s, I think that both Ben Bernanke and Janet Yellen are likely to be judged quite harshly. Once the recession of 2008-2009 had reached its end, the Federal Reserve had one overwhelming first priority: to create a strong enough economy that it could sustain short-term safe nominal interest rates of 400 to 500 basis points, and still grow at potential, in order that the Federal Reserve would have room to deal with the next recessionary shock when it came by conventional interest rate policy. The Federal Reserve did not prioritize that objective. Now here we are, late in a recovery, with short-term safe interest rates at 80 basis points or so, and with substantial fear that the economy is not robust enough to support any substantial rise over the time before the next severe recessionary shock hits. Indeed, an attempt to push short-term rates higher in the near future might well be such a recessionary shock.

The Federal Reserve has wedged itself into a position where it has almost no conventional monetary policy ammunition to deploy.

Let me say that the housing bubble did not blow up the economy. Let me say that the deflation of the housing bubble did not blow up the economy. As of the start of 2008, the housing bubble had collapsed, and all of the excess workers who had
been employed in construction had moved out and overwhelmingly found jobs in other sectors without even a small recession or more than a trivial rise in the unemployment rate.

But there was left in the bowels of the financial system the fact that the big money center banks had been playing regulatory arbitrage—claiming that the mortgage-backed securities they were holding were true AAA assets when they were nothing of the sort. It was this concentration of overvalued and mischaracterized assets in the highly leveraged money center banks that got us into big trouble, not the collapse of the housing bubble.

You can see this if you recall that the collapse of the dot-com bubble in 2000-1 took down about five times as much in the way of investors’ wealth as the collapse of the housing bubble took down the wealth of subprime lenders. And yet the 2000-1 bubble collapse did not cause a big recession. Why not? Because the people who took the hit were the rich equity investors in Silicon Valley, rather than the highly overleveraged money center banks that had decided to get a little bit too clever with how they characterized the assets they were holding.

Note that there are people like Larry Summers and Olivier Blanchard who are right now much more on now on Team Expansionary Fiscal Policy than on Team Raise the Inflation Target, in substantial part because of a desire to keep inflation non-salient and because our understanding of how bubbles are generated and what role ultra-low interest rates and quantitative easing play in generating them is very poor.

Let me underscore Jason’s point: Marvin Goodfriend is a potential future nominee to the Federal Reserve Board. Marvin Goodfriend has a remarkable aversion to and suspicion of quantitative easing. But has been very comfortable with the Federal Reserve’s interest rate management role.

When I have pitched this idea of a blue-ribbon examination of the proper inflation target in the past, what I have believed was my cleverest thought was to make Ben Bernanke and Larry Summers co-chairs, and make them in charge of figuring out where the rough consensus of—once again getting Thomas Aquinas on you—the greater and wiser part of the informed community of thinkers about this is.

I have to run to two pointless bureaucratic meetings. If you have any more questions, please email me at, and if I can hide my phone keyboard and use my thumbs I will answer during the meetings, and if not I will answer as soon as I can afterwards.

And one thing I did not say: We have had four pieces of bad news in the past decade, all of which strongly argue against preserving the two percent per year core PCE inflation target. They are:

  1. bad news about the value of the Wicksellian neutral interest rate.
  2. bad news about the public sphere’s understanding of what the non-interest rate macroeconomic policy tools are and how to deploy them.
  3. bad news about partisanship—the solid opposition of the Republican Party to the policies of South Carolina Republican Ben Bernanke because it was thought they might redound to the benefit of Obama.
  4. bad news about the strength of non-standard stimulative monetary policies.

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