2% Inflation and the Fed

The Fed seems to have a thing about 2% milk. Or was that 2% inflation? It has become a passion with them. It’s like your mom when you were a kid. Honey, if you are good we will take you to Legoland. What is good Mom? To start with clean up your room. And then you should get straight Bs. Straight Bs? Why do I need straight Bs to be good – good enough to go to Legoland?

Mom knew that I would never get straight Bs. I could hardly sit in my school desk for five minutes let alone concentrate long enough to get a B on anything. The Fed has been singing this 2% inflation song for quite a while – and all during that time the chance of inflation reaching 2% was about the same as my getting straight Bs.

Why is the Fed so disingenuous? Mostly to take our collective eye off the ball. There used to be a time when the proper role of the Fed was to provide just the right amount of liquidity to the economy and restrain inflation. But then the Keynesians messed things up and suggested that since the government is totally inept, the only organization besides Donald Trump left to control the economy is the Fed. So instead of humbly trying to  dampen inflation and inflation expectations the Fed has turned into this multi-headed hydra doing everything from dunking basketballs to fine tuning the unemployment rate.

Janet has no troubling dunking so she and her fine fellows at the Fed (notice all the Fs) have spent the last 8 years or so telling us bedtime stories about monetary policy and the unemployment rate. Janet will not rest until every last legal and illegal fast-food server has a full time job with rapidly growing wages. She is still a long way from reaching that goal so she is even more dedicated. But here’s the rub. Aged economists like myself keep reminding her that at some point after she has poured enough money onto the smoldering economy she will have created enough economic and financial imbalances to sink a manatee.

Janet wants to please even old guys like me so she gives what we might call “lip service” to the idea of inflation. Janet wants unemployment much lower (and wages much higher) and will say just about anything so she can say she slayed the employment dragon. One thing she can say is – look dudes. I poured enough money on the economy to drown China and look – no inflation. Well – there is some inflation so she had to come up with a number for the perfect amount of inflation and that number is 2%. She keeps pointing out that inflation is less than 2% and she acts as if that is a bad thing. Is it a bad thing when your money buys more? Instead of saying she wants the unemployment rate lower – she chides us with this silly statement that inflation is less than 2% and that is a bad thing! Worse – she says – we must keep stimulating the economy until we can get inflation up to 2%. 

Up to 2%!!! Am I yelling? I spent my whole 169 year career thinking the Fed is supposed to REDUCE inflation. Where did we get this raise inflation crap??? It is just like those straight Bs. Mom didn’t want to take me to Legoland. Janet does not want to raise inflation to 2%. What Janet really wants is a gold star for employment achievement.

You say – but Larry – the Fed just raised the interest rate. Are you never happy? Did you never get to Legoland? Yes, I did get to Legoland and it was wonderful. As the Fed announced its miniscule increase in the interest rate it spent more words reassuring us that the future increases will be so gradual that no one will even notice. But even that tiny little interest rate increase isn't guaranteed. If ANYTHING comes up this year that has even the tiniest possibility of slowing growth in the US economy you can be sure that the Fed will end their attempt to restore a bit of normalcy to monetary and financial conditions.

2% inflation is a gimmick and it means nothing. What matters is the Fed’s progressive agenda and that it is riveted on the unemployment rate and economic growth. Mark my words. If the inflation rate rises close to or above 2% while the employment situation is not sufficiently solved – the Fed will explain why 2% was never a rigid target. The Fed will then explain why 3% makes more sense. Hey guys, is 4% really so bad? 

Why am I so mean about the Fed? The answer is that they don't read the handwriting on the wall. First, remaining issues with employment have nothing to do with monetary policy and everything to do with long-term structural issues. Loose money and low interest rates are doing little for growth and everything to increase imbalances. Second, we already see the worrisome bubbles developing that arise from near-zero interest rates. Third, if inflation does begin to rise despite little progress on employment, the Fed will likely ignore the inflation and will end up creating a very unstable stagflationary environment. Those of you who experienced all that in the 1970s know why that is not a desirable end. 

The Fed should stop this charade about wanting a higher inflation rate and just tell the truth. They are not going to stop this abnormal monetary policy until every last one of us has a full time job and wages are growing faster than kudzu. Domestic and global imbalances be damned.