MinnEcon Blog

Mpls. Fed chief: More inflation could aid economy

Remember inflation?  The enemy of all household budgets?  One half of the "misery index," along with the unemployment rate?

The head of the Federal Reserve Bank of Minneapolis is apparently trying to rehabilitate inflation, now that it's been dormant for so long.

He told the Economic Club of Minnesota Wednesday that a little too much inflation could be a good thing for the economy and job creation.


He makes an interesting argument.

The Federal Reserve has basically failed in its efforts to bring inflation up to the target rate of 2 percent a year.

The Fed set that target in January, 2012 because of its dual mandate from Congress:  to promote price stability and promote maximum employment. But since then, Kocherlakota points out, inflation has averaged 1.3 percent per year.  Low inflation is linked with low demand for goods and services—tough times, in other words.

Kocherlakota says that below-target rate means " there is still significant underutilization of our country’s most important resource — its people."

Let's say the Fed does boost inflation to the still tame level of 2 percent.  Success?

Not necessarily, Kocherlakota argues.  Overall prices would still be lower than if inflation had chugged along at a sustained 2 percent level.

Think of climbing stairs.  If you slow down for a bit while ascending a staircase you wouldn't climb as high as you would if you were going at steady pace.   So, what if you sped up a bit to make up for the initial lag?

And, what if the Fed decided to let inflation speed up more than 2 percent for a while to make up for the current shortfall?

Kocherlakota says businesses would see that kind of policy stance, known as "price level targeting" as a sign of better days (i.e., rising demand) to come. In effect, the Fed would be signaling a longer run of low interest rates to stimulate demand.

"That expectation of higher demand would provide an additional incentive for them to hire and invest today," Kocherlakota said.   In other words, that policy could add some juice to the current lackluster recovery.

Kocherlakota lays out a compelling argument, but he stops short of endorsing "price level targeting."

He points out that he isn't tackling "the thorny and important question" of what the Fed should do about times in the past when it let inflation get too high. "But I do think that the question of whether to target the inflation rate or the price level should be a subject for serious discussion among central bankers."