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1. Good Policy or Good Luck? Why Inflation Fell Without a Recession

Author:
Thomas Ferguson and Servaas Storm
Publication Date:
09-2024
Content Type:
Working Paper
Institution:
Institute for New Economic Thinking (INET)
Abstract:
This paper analyzes claims that the Federal Reserve is principally responsible for the decline of inflation in the U.S. We compare several different quantitative approaches. These show that at most the Fed could plausibly claim credit for somewhere between twenty and forty percent of the decline. The paper then examines claims by central bankers and their supporters that a steadfast Fed commitment to keeping inflationary expectations anchored played a key role in the process. The paper shows that it did not. The Fed’s own surveys show that low-income Americans did not believe assurances from the Fed or anyone else that inflation was anchored. Instead, what does explain much of the decline is the simple fact that most workers nowadays cannot protect themselves by bargaining for higher wages. The paper then takes up the obvious question of why steep rises in interest rates have not so far led to big rises in unemployment. We show that recent arguments by Benigno and Eggertson that shifts in vacancy rates can explain this are inconsistent with the evidence. The biggest factor in accounting for the strength in the economy is the continuing importance of the wealth effect in sustaining consumption by the affluent. This arises, as we have emphasized in several papers, from the Fed’s quantitative easing policies. Absent sharp declines in wealth, the continuing importance of this factor is likely to feed service sector inflation in particular.
Topic:
Economics, Monetary Policy, Federal Reserve, Inflation, and Macroeconomics
Political Geography:
North America and United States of America

2. Was Something Structurally Wrong at the FOMC?

Author:
Alan S. Blinder
Publication Date:
10-2024
Content Type:
Policy Brief
Institution:
Peterson Institute for International Economics (PIIE)
Abstract:
There is little doubt that the Federal Reserve was late to start raising interest rates as inflation rose in 2021–22. The Federal Open Market Committee (FOMC) made a substantial, though perhaps understandable, error in failing to raise interest rates until March 2022. Much of that policy error can be attributed to faulty forecasts of inflation, which the Federal Reserve shared with many other forecasters. It was not an outlier. But the error was not quite as consequential as the Fed’s sharpest critics allege. Even if the FOMC had started to hike rates earlier, the econometric evidence suggests that the effects on peak inflation would likely have been small. Supply constraints, not excess demand, ruled the roost. They came, driving inflation higher; and then they went, pulling inflation down. Blinder says that the FOMC’s August 2020 framework shoulders more of the blame for the inflationary surge than it should—probably because the new wording revised both of the Fed’s goals, low inflation and high employment, in dovish directions. For that reason alone, the framework will almost certainly be changed in 2025, given the high inflation since. But how? Blinder suggests that the August 2020 change in the employment goal, from symmetry to “shortfalls,” is sensible and probably not too important anyway. But the change in the inflation goal, from a 2 percent point target to flexible average inflation targeting (FAIT), was probably consequential. It may have made the FOMC slow on the draw as inflation gathered steam, and it may have kept monetary policy too tight for too long in 2024. In both directions, Blinder argues, a 1.5 to 2.5 percent target range would be a better choice. To answer the question in the title of this Policy Brief, that may be the structural flaw the Fed should fix.
Topic:
Economics, Monetary Policy, Federal Reserve, Interest Rates, and Supply
Political Geography:
North America and United States of America