“Opportunistic Disinflation”

Via Scott Sumner, Paul McCulley discusses the strange theory of “opportunistic disinflation” that was bandied about in Fed circles in the late 1980s:

Simply put, the theory said, the Fed should not deliberately induce recessions to reduce inflation, but rather “opportunistically” welcome recessions when they inevitably happen, bringing cyclical disinflationary dividends. A corollary of this thesis was that the Fed should pre-emptively tighten in recoveries, on leading indicators of rising inflation, rather than rising inflation itself, so as to “lock-in” the cyclical disinflationary gains wrought by recession. While the label “opportunistic disinflation” was a clever one, the Fed had actually been practicing the policy for a long time. Indeed, former Philadelphia Fed President Edward Boehne elegantly described the approach at a FOMC meeting in late 1989:

“Now, sooner or later, we will have a recession. I don’t think anybody around the table wants a recession or is seeking one, but sooner or later we will have one. If in that recession we took advantage of the anti-inflation (impetus) and we got inflation down from 41/2 percent to 3 percent, and then in the next expansion we were able to keep inflation from accelerating, sooner or later there will be another recession out there. And so, if we could bring inflation down from cycle to cycle just as we let it build up from cycle to cycle, that would be considerable progress over what we’ve done in other periods in history.”

In other words, maybe the Fed isn’t undershooting its 2 percent inflation target. Maybe it’s secretly decided that it dreams of reducing the 2 percent target to a 1 percent target and wants the labor market to remain anemic until this curve drops even lower. Sumner notes that the phenomenon of the “jobless recovery” starts occurring at precisely the moment when the Fed adopts this doctrine.