America’s central bankers ought to be focused on revving the economy and adding jobs—period.
There’s no excuse for the Federal Reserve’s dawdling—not even its obsessive concern that inflation is too low. At 1.4% year on year as of July, core inflation is below the Fed’s target of 2%, but that goal is arbitrary and unrealistic for today’s economy. When the Federal Open Market Committee meets this week it should put aside this inflation fixation and raise interest rates, which have been dangerously low for much too long.
The current economic recovery has been the slowest in recent times, despite the lowest interest rates in history for the longest time. Easy money has benefited mainly the wealthy, while average consumers have been getting close to zero interest on their savings accounts. This is particularly tough for retirees who do not participate in the stock market.
Low inflation, on the other hand, has been good for the U.S. economy, workers and the middle class, including retirees living on fixed incomes. Over the past five years, hourly earnings in the private workforce are up 2.2% a year on average, which is only about half of what might be expected in a normal economic recovery. But thanks to low inflation, workers have gained some real income.
Higher inflation does not create greater economic growth. To the contrary, it is greater economic growth that can lead to higher inflation. Therefore, the Fed ought to be focused on revving the economy and adding jobs—period. One reason business investment has been very weak for eight years is the lack of confidence in Washington’s monetary and fiscal policies.
The only legitimate reason to increase inflation artificially is to avoid deflation, which can indeed be dangerous. If consumers become convinced that prices will drop over time, they begin to postpone purchases, thereby slowing economic growth.
But to find out if this is happening, the metric to look at isn’t inflation. It is the savings rate. If consumers have money and don’t spend it, then obviously the savings rate must go up. There is no evidence that it has done so to any significant degree world-wide. In the U.S., the opposite is occurring: The savings rate slid to 3.5% as of July, down from 5.1% a year earlier.
As long as the economy and employment continue to improve, the Fed should stop fretting about low inflation and move to normalize monetary policy. Ideally it could reach interest rates of at least 2% by the middle of next year, up from 1.25% today. That would be a good middle ground. If economic growth then slowed, the Fed would have room to maneuver by ticking rates down. But if inflation increased, it could quickly raise rates to the equilibrium level.
The Fed should also start, at the FOMC meeting this week, reducing its outsize balance sheet, so as to let the markets begin to function properly. Before the recession of 2008-09, the Federal Reserve’s balance sheet had never reached $1 trillion. Today it stands at $4.5 trillion, or 25% of Washington’s entire public debt. The Fed’s eight-year intervention in the markets has helped push asset prices—including the stock market, long-term bonds, and at least some commercial real estate—so high as to raise concerns of a bubble. Should it burst, the effects could be catastrophic, shattering confidence in the economy. The Fed would feel pressure once again to bail out the wealthy with monetary policies that artificially support risky assets.
The incomes of many Americans are flat or declining, and thousands who want work still cannot find a decent job. What built this country’s prosperity was the unparalleled success of America’s free-market system. If the Fed wants to help, it should forget its inflation worries, get out of the way, and let the markets operate.