The Inflation Slope Is Not That Slippery

Let me pick up and quote from Featured Guest Andrew Harless:

[S]tability is the main advantage cited for a low-inflation regime. We are comfortable with 2% per year inflation, but higher rates could be a slippery slope, as in the 1960s and 1970s. And even if we do not slide down the slope, its potential existence will make people nervous, be a drag on the economy and produce excessive volatility. Yet that does not seem to have been a major problem from 1983 to 1991, when the Fed successfully maintained a stable inflation rate in the 4-5% range. If economic stability is our goal, the real resilience provided by a higher inflation rate should trump the illusory comfort provided by a lower one...

Between the end of the early 1980s recession and the end of the early 1990s recession, inflation in the United States fluctuated between 1.5% and 6.0%--but at no time was there any lack of confidence in the Federal Reserve's long-run commitment to low inflation, at no time did the United States slide down the slippery slope, and if there were any complaints that any average inflation rate of 4% during that decade noticeably degraded the functioning of the price mechanism, I have not heard them.

Between the end of the early 1990s recession and the end of the early 2000s recession, inflation in the United States fluctuated between 1.7% and 6.0%--but at no time was there any lack of confidence in the Federal Reserve's long-run commitment to low inflation, at no time did the United States slide down the slippery slope, and if there were any complaints that any average inflation rate of 3% during that decade noticeably degraded the functioning of the price mechanism, I have not heard them.

Between the end of the early 2000s recession and the start of the subprime crash, inflation in the United States fluctuated between 1.25% and 4.5%--but at no time was there any lack of confidence in the Federal Reserve's long-run commitment to low inflation, at no time did the United States slide down the slippery slope, and if there were any complaints that any average inflation rate of 3% during that period noticeably degraded the functioning of the price mechanism, I have not heard them.

The argument that an average inflation rate of more than 2% per year sends us sliding down the slippery slope is unsupported by the evidence of the past generation. The breakdown and the slide down the slippery slope in the 1970s seems, to me at least, to have been the result of four factors:

1. A productivity slowdown that significantly lowered the warranted rate of real wage increase.
2. Johnson's and then Nixon's eagerness to push the edge of aggregate demand for political purposes.
3. Bad luck on the side of energy prices.
4. An economics profession that had not yet learned the lesson of Milton Friedman and Ned Phelps that a government that takes its eye off price stability will not trade off inflation for high employment but instead get both high inflation and low employment.

I do not believe we will have such a perfect storm again. I cannot see any strength to the argument that we are materially guarding against such a storm by setting our inflation target at 4%/year rather than 2%/year. And I can see a lot of strength to the argument that a 2%/year inflation target risks terribly destructive macroeconomic episodes like--well, like right now.