Rogoff Saying This Time Different Calls for Reflation
The economist whose research foreshadowed the unusually long slog back from the 2008 financial crash is calling for the unlikeliest kind of central banker to lead the Federal Reserve: one who welcomes some inflation.
Harvard University Professor Kenneth Rogoff, whose influential 1985 paper endorsed central bankers focused more on securing low inflation than on spurring employment, is highlighting the benefits of a Fed led by either Janet Yellen or Lawrence Summers precisely because they fail his old litmus test. President Barack Obama said Aug. 9 that they are “outstanding” and “highly qualified” candidates to replace Ben S. Bernanke, whose term as chairman runs out in January.
What qualifies them in Rogoff’s view is their dovishness, a refusal to place too much weight on stable inflation at a time when unemployment is far above its longer-run level. Rogoff is espousing aggressive monetary stimulus, even at the cost of moderate price increases. At a time of weak global inflation, higher prices may even help the U.S. economy by lowering real interest rates and reducing debt burdens, he said.
“In more normal times, you’re looking for the central banker to be an anchor against high inflation expectations and to assure investors that inflation will stay low and stable to keep interest rates down,” Rogoff, co-author with Carmen Reinhart of the 2009 book “This Time Is Different: Eight Centuries of Financial Folly,” said in an interview. Now “we’re in this situation where many of the central banks of the world need to convince the public of their tolerance for inflation, not their intolerance.”
Central banks across the developed world are struggling with inflation that’s too low. Consumer price increases in all but one of the Group of Seven economies are currently running under 2 percent, which has become the standard goal in recent years for monetary authorities. Two years ago, deflationary Japan was the only country struggling with below-target inflation.
“If you look at the biggest challenges we have, the challenge is not inflation,” Obama said in a press conference last week. “The challenge is we’ve still got too many people out of work, too many long-term unemployed, too much slack in the economy.”
In the U.S., inflation has been below the Fed’s 2 percent target for 14 months in a row, even as the central bank has expanded its balance sheet to a record $3.59 trillion in an effort to support the economic recovery.
St. Louis Fed President James Bullard dissented from the Federal Open Market Committee’s June 18-19 decision, arguing the Fed should signal its readiness to push inflation higher. Bullard later said the Fed shouldn’t begin dialing back its bond purchases when “inflation is sinking.” At its next meeting July 30-31, the FOMC added language to its statement saying persistently slow price gains “could pose risks to economic performance.” Bullard joined the majority in that decision.
Policy makers for the next three or four years “will be focused on the problem of reviving the economy,” said Joseph Stiglitz, a Nobel laureate and a professor at Columbia University in New York. “The likelihood that inflation is going to be a problem is very, very small. I think there’s a growing consensus that the use of that policy to continue to stimulate the economy and avoid deflationary expectations is going to be one of the key issues.”
Both Yellen and Summers have signaled a tolerance of and even a preference for some price gains, even at a time when many held that no inflation would be best. In remarks published in 1991, Summers argued that a policy leading to zero inflation would be “disastrous” because it would rob the central bank’s ability to drive real, or price-adjusted, interest rates negative to spur borrowing.
“The optimal inflation rate is surely positive, perhaps as high as 2 or 3 percent,” he said then. “I would support having someone in charge of monetary policy who is more inflation averse than I.”
Less than a year after first joining the Fed board as a governor in 1994, Yellen argued against setting a singular inflation goal because it could prompt officials to neglect their responsibility to support growth.
“When the goals conflict and it comes to calling for tough trade-offs, to me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target,” she said, according to transcripts of the FOMC meeting of Jan. 31-Feb. 1, 1995.
In 1999, she echoed Summers’s point, noting research that “a little inflation” may actually be necessary for a healthy economy because it’s difficult for employers to cut their workers’ nominal wages.
“The attempt to push inflation too low could permanently raise unemployment and reduce the scope for monetary policy,” she said.
To some extent, the Fed has codified those early views espoused by Summers and Yellen by, for the first time, adopting a 2 percent longer-run inflation target in January 2012. Fed officials further specified in December that they would be willing to accept an inflation outlook that’s as high as 2.5 percent to bring unemployment down to 6.5 percent. That was revised from Chicago Fed President Charles Evans’ proposal that the Fed signal it would be willing tolerate price gains of as much as 3 percent.
“I would have picked a number more like 4 percent and I think it would have been helpful in helping reflate the economy,” Rogoff said. The selection of the new Fed chair “will have a big influence on expectations.”
The idea of signaling a temporarily higher inflation goal, when the central bank’s interest-rate target is stuck at the so-called zero lower bound, is based on more than a decade of academic research. In 2000, Bernanke, then a professor at Princeton University, suggested deflationary Japan pledge to target 3 percent to 4 percent inflation for “a number of years,” citing research by Paul Krugman, now a Nobel laureate.
In 2010, Chicago’s Evans advocated targeting a path for the price level, in which the Fed would say it seeks higher-than-normal inflation until it makes up for the “inflation deficit” the economy has been running since December 2007, when the recession began. The idea gained little traction on the FOMC, and Bernanke repeatedly rejected stating a higher inflation objective for the U.S. when it, unlike Japan, wasn’t in deflation.
“We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation,” he told a news conference in April 2012. “To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side” would be “unwise” and “very reckless,” he said.
The Fed won’t risk allowing medium-term inflation to deviate above 2.5 percent, even under the stewardship of someone like Summers or Yellen who understand the dangers of deflation, according to Ethan Harris, co-head of global economics at Bank of America Corp. in New York. Even Rogoff acknowledges there’s little stomach at the Fed for more than that already-stated ceiling.
“Once you accept higher inflation, it becomes a slippery slope and eventually you get to inflation that really hurts the economy a lot,” said Harris. “Everyone remembers that episode quite well” of above-10 percent inflation in the 1970s and 1980s “and that would be true for all the candidates for the chairmanship.”
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