When to Worry About Inflation

One of the most bizarre aspects of the curiously persistent inflation hawks of the Fed is their insistence that there’s something mysterious about when would be an appropriate time for a central bank to start worrying less about unemployment and more about inflation. To me it seems obvious that if unemployment is unusually high and inflation is unusually low, then you worry about unemployment.

The time to switch is when either the unemployment rate is back to normal, or else government inflation statistics measure an above-trend amount of inflation.

The implicit reasoning of the monetary policy mysterians seems to be that it would be so horrible to experience so much as a single quarter of above-trend inflation that the Fed ought to be trying to guess when this dread elevated inflation will arise and head it off at the pass. But why? Sometimes your rate is going to be above trend and sometimes it’s going to be below trend. It’s been below trend for a while now. A bit of time above trend isn’t going to kill anyone. Ten percent unemployment, by contrast, really might. And if for some reason you really do think it’s vital to peer around the corner, you could look at the TIPS spread or something.

The fact that we have Fed governors running around talking about their determination to choke growth even if unemployment remains high even in the absence of clear evidence of any sort of well-defined inflation problem seems to me to be exactly the kind of thing that guarantees we’ll be stuck with low levels of business investment despite the low interest rates. Low interest is nice, but it’s only worth taking out a loan if you think you’re going to have customers.