“At a certain point the excuses for inflation’s persistence will wear thin—even if they are valid,” warns JonSteinsson. “The public will simply lose confidence in the Fed”
steadily for over a year, inflation in America is now higher than it has been for four decades. On May 4th the Federal Reserve raised the federal funds rate by 0.5 percentage points. Jerome Powell, its chair, also indicated that further 0.5-percentage-point increases are likely in June and July. Together, these actions will constitute the fastest tightening of policy since the 1980s.
Even now some critics see the Fed‘s current stance as falling short. Markets currently expect it to raise rates to about 2.75% by the end of the year, and only by about 0.5 percentage points more next year. The Fed‘s own forecast from March had inflation at 4.3% at the end of this year and 2.7% at the end of 2023. This same forecast had unemployment remaining at record lows for the foreseeable future.
There are differences, however, between today’s situation and that of 40 years ago. Arguably, the most important is the credibility the Fed has built up since then thanks to its inflation-fighting. In the early 1980s, its credibility was in tatters after a decade of high and volatile inflation. But the Fed’s relentless focus on bringing about low and stable inflation meant that by 2000 its credibility was sky high.
The case for an “immaculate disinflation” today rests on longer-run expectations about inflation continuing to be solidly anchored at the Fed’s target of 2%. If this remains the case, it is entirely possible that inflation will simply return to target as the disturbances associated with covid-19 and the war in Ukraine dissipate. In this scenario, there is no need for particularly tight policy.
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