Rick Rieder argues that the Fed’s price stability mandate has been fulfilled and that today’s drivers of inflation are being misunderstood. Ultimately, the Fed’s mandate should evolve away from inflation targets in favor of other measures.
In the U.S. today, despite the lowest levels of inflation volatility in the last 60 years, policy makers and market participants alike place an excessive focus on the Federal Reserve’s 2% inflation target, in our view. To understand how we’ve arrived here, we think it useful to provide context with a brief history of the Fed’s inflation mandate, and from there we take a fresh look at what we think are the true drivers of inflation. Finally, assessing the forward-looking balance of risks informs our view that the Fed should place greater emphasis on targeting other metrics, such as nominal GDP, which though an imperfect indicator of well-being, may be more indicative of overall economic health.
A brief history of the Fed’s inflation mandate
From 1965 to 1985, inflation in the United States represented a much different risk than it does today. The Fed was determined to contain inflation in any way possible, which was rising precipitously as baby boomers began entering the workforce, and women headed to work in much greater numbers. Further, oil price shocks in 1973 and 1979, along with other factors, exacerbated both absolute levels of inflation and the volatility of price changes. Given the very high outright level and volatility of inflation in this era (see first graph), in 1977 the Fed was tasked by Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” As the population growth influence peaked in 1980, inflation calmed. Yet, as the children of the baby boomers hit the workforce another (smaller) wave of population growth saw inflation re-accelerate toward 6% in the late 1980’s, which sparked unfounded fears of another 1970’s experience.
As a result, the Fed implicitly adopted a 1.5% to 2.0% inflation target range in the early-1990s in a renewed effort to tame prices. As population growth continued to cool, inflation slowed simultaneously, until 2008 when inflation volatility spiked again–this time in the form of disinflation; so in 2012 the Fed decided to adopt an official target at the high-end of its range: 2.0%. We can see that there is no magic to 2% inflation exactly; rather, this target is simply meant to stand in as a proxy for stable prices. Moreover, when considering the fact that the volatility of prices is as low (stable) as it’s been in the past 60 years, in addition to looking at the low absolute levels of inflation, we think it suggests that price stability has been achieved by the Fed for the time being.