The Think Tank: Macro Discussion and Opportunities Brainstorming

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I didn’t think much when I saw this piece 2 days ago, where some prof made the case for a 3% inflation target:

https://www.wsj.com/articles/the-fed-should-carefully-aim-for-a-higher-inflation-target-reserve-powell-greenspan-5fef5051

But then today, Nick the Fed Whisperer said this:

Officially, the Fed’s target for inflation is 2%. With inflation running well above that number, officials are still focused on whether to raise rates one more time this year. But that is a relatively small consideration compared with the bigger question of how long to keep rates at that high level.

Fed officials could try to get to 2% quickly, such as by the end of next year, by raising rates higher and only slowly reducing them as the economy weakens. That would risk a sharper downturn and possibly kill the chances of achieving the soft landing.

On the other hand, if they’re satisfied that inflation is slowing durably, they could hold them at their current level and consider trimming rates later next year. That would take more time to get to the inflation target—around three years.

What if getting to 2% isn’t worth the pain? Another strain of thinking says the Fed should accept a rate around 3% as the new target. Powell and other Fed officials say moving the goal posts like that isn’t an option.

The challenge of finishing the fight against inflation will likely be a big topic of debate for central bankers when they gather for the Kansas City Fed’s annual retreat in the mountains of Jackson Hole, Wyo., where Powell is set to speak Friday.

While Nick suggests the Fed does not consider 3% as an option, this has now introduced the thought into the public domain.

The Fed is not like the BoJ, and so is as anti-surprise as possible. Since the next target consideration is in 2025, it would make sense for him to “start thinking about thinking about raising the inflation target.” And JH - where policy wonks discuss policy - would be a perfect venue for this.

Let’s keep an ear open for this on Fri:

  • If he so much as hints at a 3% target, it will begin the unanchoring process of inflation expectations, and all kinds of bearish reactions.
  • If he dismisses this notion as vigorously as before, markets will likely breathe a sigh of relief, which would be bullish.
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