Raise the Inflation Target and Put a Date on It! That’s the direction some high-profile economist and former members on the FOMC want to go. According to these academics, including Narayana Kocherlakota the former president of the Federal Reserve Bank of Minneapolis from 2009 to 2015, raising the inflation target just isn’t enough. They want to put a time horizon on it as well. In other words, they want to raise the inflation target higher than the current 2% level, and then place a firm date as to when that inflation goal must be achieved.
Their rational for doing both actions is to reduce the level of real interest rates, which they somehow believe is the progenitor for viable GDP growth. You see, once the Fed has taken the nominal Fed Funds Rate to zero, there isn’t much more room to the downside unless these money manipulators assent to negative nominal interest rates. But charging banks to hold excess reserves is fraught with danger, and so far this idea has been eschewed in this country and has been proven ineffectual in Europe.
The Fed wants the flexibility to make real interest rates more negative than the minus 2% that would be achieved at the zero-bound rate when using the current 2% inflation target.
The next recession could be just around the corner and the Fed is thinking about ways to stimulate the economy given the fact that the amount of ammunition--the number of rate cuts until the F.F.R. hits zero percent--is extremely limited. With very little leeway available to reduce borrowing costs, these mainstream academics want to facilitate more negative real interest rates by ensuring inflation is higher right from the start.
The math is simple: a three percent (or higher) inflation rate would equate to at least a minus three percent real F.F.R. once the nominal rate hit zero. But as to why these Keynesian academics are so convinced a lower real interest rate is better for economic growth is never clearly explained. Probably because it is a nonsensical tenet and the biggest fallacy in all of central bank group think. Their spurious logic dictates that a lower unemployment rate is the primary cause of rising rates of inflation and that a higher rate of inflation is supportive for lowering the unemployment rate. Exactly how this simple model arrives at that conclusion is never cogently explained; other than the mistaken belief that inflation and growth are synonymous terms.
But history and genuine economics clearly illustrate that inflation does not bring about growth, nor does it necessarily lower the unemployment rate. In fact, a rising rate of inflation often leads to higher rates of unemployment. This is the exact opposite of the Phillips Curve dogma held at the Fed, which dictates that a falling unemployment rate is the totality of inflation.
By Michael Pento