The entire conversation around this week’s Federal Reserve meeting is over whether and how rapidly the Fed will implement or signal the future implementation of tighter money via a “tapering” of its bond purchases. But the question is: Why? Today the Bureau of Labor Statistics reported that over the past 12 months we’ve seen 1.4 percent CPI inflation. If you restrict your attention to “core” inflation, which is the more reliable indicator for monetary policy purposes, we have 1.7 percent inflation over the past year.
Now just close your eyes and forget everything that’s happened since the zero bound. What happens when inflation comes in below target? What happens is we say “this is good news for the American economy, because it means the Fed is going to cut interest rates and boost output and employment secure in the knowledge that there are no inflation pressures to worry about.” The zero bound, of course, makes all kinds of differences to the Fed’s practical operations and capabilities. But it in no way undermines that basic logic. If we had 2.3 percent core inflation and 2.6 percent headline inflation, then there’d be a real reason to tighten monetary policy. Given the high unemployment rate, there’d also be a reason to resist that pressure to tighten. But we’re not 0.3 percentage points above the inflation target, we’re 0.3 percentage points below the inflation target. Even if the unemployment rate were dramatically lower, tighter money would still be perverse.
With joblessness high and inflation low, the right policy is clear—easier money, not tighter.