Paul Volcker Denounces Return To Volcker-Era Inflation

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My pet idea for increasing the American inflation target is that we should aim for Reagan-era levels of inflation, averaging around 4 percent. In monetary policy circles, those would be known as Volcker-era levels of inflation. The point either way is that America had a serious inflation problem in the 1970s, and by the mid-to-late 1980s, everyone generally felt the problem had been solved. So why not go back? Volcker himself turns out to disagree with me:

Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

Three points in response. One is that this idea that doing demand-side work is somehow a distraction from or an alternative to tackling “real” problems is one of these things people say but I don’t think has real evidence for it. The second is Karl Smith’s point that 2 percent inflation is actually too little inflation and leaves us way too prone to near-zero nominal short-term interest rates any time there’s a recession.

Last, I would turn the slippery slope point around. In the ’70s, inflation was clearly too high. So Volcker and his colleagues brought it down by producing a brutal recession. Then around 1990, Volcker’s successors nipped a new inflationary cycle in the bud with another recession. But this time, they brought inflation down to a lower level than it had been before the eighties. Why? What goal did this “opportunistic disinflation” serve? To me it looks precisely like mindless slope-slipping. Having been roundly congratulated for whipping inflation, policymakers decided to gain even more kudos by driving it even lower. But this hasn’t helped anyone, and, indeed, the best economic times of the past 30 years were the years in the late-1990s when Alan Greenspan let inflation hover around 3 percent before raising interest rates and inaugurating the ensuing 10 thin years.