The Fed has secretly adopted new inflation target, economist says

The Fed will cut rates even though inflation is still above the official target, according to New York Times bestselling economist Lawrence McDonald

By Sam Bourgi

•

04 September 2024

The Fed has quietly adopted a higher inflation target than the official 2%, according to economist and New York Times bestselling author Lawrence McDonald.

“The Federal Reserve is kicking off a rate-cutting cycle with core PCE nowhere even close to the 2014-2019 norm,” said McDonald, referring to the central bank’s preferred core Personal Consumption Expenditures Index.

“Clearly, they have chosen a new, higher inflation target in reality. They will publicly say this in the coming years,” he explained.

The core PCE index slowed to an annual rate of 2.6% over the summer but remains well above the sub-2% average before the pandemic. It’s also higher than the central bank’s long-standing 2% target.

Under normal circumstances, the Fed would consider the current inflation rate too high to justify rate cuts. However, the Fed’s priorities have shifted from one extreme to the other since the pandemic.

Last month, the Fed accelerated its timeline for rate cuts when unemployment spiked to multiyear highs and government economists revised down job-growth figures over the past year.

Because of this, many economists think it’s about time the Fed moves on from its “arbitrary” inflation target.

There’s nothing special about 2%

Although Fed policymakers claim that their 2% inflation target is based on solid economic theory, the reality is much more complicated.

A 2021 paper published by Fed economist Jeremy Rudd concluded that the 2% target “rests on extremely shaky foundations” and that “adhering to it uncritically could easily lead to serious policy errors.”

“The idea that inflation should be relatively low and relatively stable is certainly a reasonable position to have,” said Jonathan Kirshner, a political science professor at Boston College. “But there’s nothing magic or special about 2%.”

According to Nobel Prize-winning economist Joseph Stiglitz, the Fed’s current inflation target is completely arbitrary because “no economic science says how fast you should go back to whatever goal” policymakers think is appropriate.

In Stiglitz’s view, policymakers should focus more on keeping inflation within certain parameters.

Economists like Moody’s Mark Zandi, Harvard’s Jason Furman, and Queens’ College president Mohamed El-Erian believe a higher inflation target is more realistic in today’s economy. In Zandi’s view, the Fed could achieve its price stability mandate with inflation closer to 3%.

Nevertheless, some economists think the Fed has shot itself in the foot by giving specific inflation targets—a phenomenon that began in 1996.

Laurence Ball, an economics professor at Johns Hopkins University, said former Fed Chair Alan Greenspan didn’t believe in a public-facing numerical inflation target and that he “went to comical lengths to not define what he meant by price stability.”

The Fed has secretly adopted new inflation target, economist says

There’s nothing special about 2%

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