New paper by John Williams of the San Francisco Fed for the Brookings Papers on Economic Activity series makes the case that targeting a 2 percent inflation rate is probably too low:
In “Heading Daedalus: Optimal Inflation and the Zero Lower Bound”, John Williams of the Federal Reserve Bank of San Francisco finds that 2 percent inflation may not be enough to prevent any future great recessions from occurring when the Federal Reserve is forced to lower the funds rate to zero frequently. While the Fed’s holding of the interest rate to zero in late 2008 and throughout 2009 has not materially contributed to the sharp declines in output in the United States and many other economies, it has been a significant factor in slowing recovery, he says, projecting that it will cost about $1.7 trillion in terms of lost GDP over the next several years. His model found that “an additional 2 to 4 percentage points of rate cuts would help bring the unemployment and inflation rates more quickly to longer-run values, but the zero lower bound precludes these actions,” he writes.
Interesting. On the other hand, if we were to eliminate cash we’d be able to get around the zero bound problem and run low inflation without facing this risk. And I assume that some day we really will eliminate cash, though that day’s probably a way’s off.