The confusion in the Fed’s statement is the conflation of the level of inflation with its trend. That is, if the public expects inflation to stay pretty much where it is, i.e., if inflationary expectations are “well-anchored,” then it’s not clear why the “public’s ability to make accurate … etc.” would be fine at a 2 percent anchor, but a problem at a 4 percent anchor.
True, history shows there’s more variance (i.e., jumpiness) around the path of inflation when it’s higher, but that’s pretty much automatic — regression to the mean: When a variable is higher than usual, it’s likely to drop back to something closer to its mean level. Again, the key is where the Fed sets the anchor, and 2 percent is but one plausible choice.
I vaguely remember some other explanation: The central bankers who first decided on 2 percent, which is a common target throughout advanced economies, believed that the measured inflation rate was biased up by something like this amount. So they were really trying to set the target rate at zero. If so, that sounds like a great way to tempt the ZLB, deflation and high real interest rates.
The fact is that the target is 2 percent because the target is 2 percent. Were the target 3 percent or 4 percent, you’d be reasonably asking me, why 3 or 4? To the extent that there’s an anti-inflation bias among economic elites (and thus an anti-full-employment bias), and I think that’s often the case, I’d reiterate arguments I made here.
I spent the day Wednesday at a great conference on measuring slack in the economy with some of the top flight folks in the business. And these analysts were not just smart, but honest. It was widely admitted that these days we don’t have much of a handle of the relationship between slack and price dynamics (technically: the current dynamics of the Phillips curve, which plots the relationship between inflation and unemployment, are poorly understood, but it is widely judged to be flat right now, such that feedback from labor market slack to inflation is historically low).
In that regard, I’d argue, as did Chicago Fed President Evans on Wednesday (brilliantly, I thought). In the face of a) our limited understanding of the dynamics in play, b) a Fed with strong anchoring instincts and a huge armory of anti-inflation ordinance (lots of room to move rates up and a $4 trillion balance sheet to unwind), and c) asymmetric risks: the current risks of whacking the recovery appear far greater than the risks of spiraling inflation, the right move in terms of tightening is patience … a lot of patience.