What If the Fed Just Lets Inflation Run for a While?

At this point in the economic cycle, monetary policy is a waiting game. The Federal Reserve believes it has met its mandate of full employment. Inflation is just about at its target. The central bank’s plan, as my colleague Tim Duy has discussed, is to raise interest rates quarterly until back to roughly the Fed's estimate of neutral policy. Once policy is back to neutral, officials will be looking for signs of inflation overheating, at which point they'd likely tighten policy past neutral, restricting and perhaps ending the growth phase of this economic cycle.

But while this strategy would succeed in cooling off any overheating the economy may experience over the next several quarters, it would fail to address the emerging challenges that higher prices would reveal. Inflation resulting from supply bottlenecks like we're starting to see is very different from inflation resulting from excess investment like we've seen in the past. If the Fed is willing to see it, there is plenty of evidence now that inflation targeting itself is a misleading objective for monetary policy.