That’s way more art than science, which it why it draws so much scrutiny. Progressive economists such as myself tend to argue these days that because inflation has been so low for so long, the Fed can and should test the waters on how low the unemployment rate can go. This isn’t because we don’t care about inflation — the point of this note is that we do (or should). It’s because, as Andrew Van Dam writes in Friday’s Washington Post, the benefits of the long expansion have only recently started to reach the least advantaged workers. Thus, if inflation remains tame, why take away the punch bowl just as folks who’ve been left behind finally pull up to the party?
It’s that “tame inflation” part I wanted to expound on for a moment. As the figure below reveals, inflation is, in Fedspeak, extremely well-anchored. The plot is of the Fed’s preferred price gauge, the core PCE deflator, with their 2 percent target in the figure, as well. “Anchored inflation” simply means that despite pressures that we might expect to be pushing price growth up, thereby threatening half of the Fed’s mandate (“stable prices”), inflation has remained at or below target. As the end of the figure shows, price growth even dipped a bit in the latest reading, even as unemployment has fallen to near-50-year lows, and wage growth has sped up.
So, those of us who favor even lower unemployment should be joining President Trump in clamoring at Fed chair Jerome H. Powell to keep his feet off the brakes, right?
Not really. We should, as Jason Furman did in the Wall Street Journal earlier this week, be suggesting a possible pause in the rate-hike campaign, depending on what the data say (Minneapolis Fed president Neel Kashkari made the same argument). But Fed governors place a very high value on anchored inflation, and those of us who value very low unemployment should share their enthusiasm.
Here’s what I mean. Were inflation not so well-anchored, the Fed would simply not allow the unemployment rate to fall as low as it has. While there’s a range of sentiments about this on the committee that decides rates — inflation hawks and doves — their mandate is what it is, and if prices were rising faster (if they became “de-anchored”), they’d be raising rates a lot more quickly to push the jobless rate back up, and fast (which could, and has in the past, triggered a recession). If their “normalization” campaign — the steady rate hikes that began in late 2015 — is supporting the inflation anchor, then it’s also allowing them to accommodate much lower unemployment than most of them argue is consistent with stable prices.
To be clear, there’s a deeper argument — one to which I’m sympathetic — that says all this anchoring and inflation/unemployment trade-off stuff is bunk, just mercurial concepts dreamed up by economists with too much time on their hands. In a global economy, prices are a function of the supply of goods and services (that’s certainly the case with oil, though oil’s left out of the core-price figure above), there’s way more slack in the labor market than the Fed thinks, and no one fundamentally knows the right model, anyway.
But that’s a much bigger argument. What matters for sustaining very low unemployment is not what I think is the right model. It’s what the Fed thinks is the right model, and believe me, it thinks it has anchored inflation, both actual and expected, and that a slow rate-hike campaign, perhaps with a strategic pause here and there, is necessary to maintain the anchor.
And who knows? It might be right!