The editors of the Washington Post disagree with President Trump:
“Inflation is defeated,” President Donald Trump declared at the Detroit Economic Club. His Tuesday remarks came hours after the Bureau of Labor Statistics announced that annualized inflation remained 2.7 percent in December, 35 percent higher than the Federal Reserve’s target.
Two things can be true at once: the pressures that took the inflation rate to a staggering 8 percent in 2022 have largely subsided. This is presumably what the president is trying to tout. But prices are still rising, particularly in areas that consumers really feel, such as food and drink costs.
I’m with the editors on this one. Inflation has not been defeated. It has merely been slowed from the excessive levels it reached when policy rates were held too low for too long. Inflation is not an enemy that can be “defeated” once and for all. It is a rate of change. As long as it is positive, the price level continues to ratchet upward. What has happened is not victory, but deceleration.
We can also say with some confidence as to why President Trump is making this claim. Not only does he want to take credit for it but he wants interest rates to be lower. He has said as much on more than one occasion. Under the Taylor Rule, given current inflation and output gap estimates, rates would be modestly higher, not lower.
The editors then touch on something that deserves additional comment:
Consecutive administrations have adopted this bad habit of talking about “falling” prices, when they really mean increases are slowing.
I think they are taking their cue from the Federal Reserve itself. The Fed routinely conflates predictably rising prices with price stability. This is a redefinition, not a discovery.
The 1977 amendment to the Federal Reserve’s 1913 empowering statute conferred on the Fed the so-called “dual mandate” of stable prices and low unemployment.
The dictionary definition of stable is unvarying not rising predictably.
I’m not entirely sure why the Fed adopted this. I think the most charitable explanation is that the Federal Reserve governors had a pretty good idea of how they could induce prices to rise slowly and predictably but didn’t know how to keep them stable. They defined success as what they were capable of producing.
Presently, most economists favor a small and steady rate of inflation.[69] Small (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly to a recession, and reduces the risk that a liquidity trap (a reluctance to lend money due to low rates of interest) prevents monetary policy from stabilizing the economy.[70] However, low interest rates don’t always cause nominal increases of price. Money supply growth may instead result in stable prices at a time in which they would otherwise be decreasing. Some economists maintain that with the conditions of a liquidity trap, large monetary injections are like “pushing on a string”.
https://en.wikipedia.org/wiki/Fiat_money
It is because of the current monetary system by design has to have some inflation to stay stable.
I am confident every Fed board member knows how to achieve stable prices; to go back to the gold standard or make the reserve asset of the monetary system a bearer asset which has a real cost to produce (and cannot be made more efficient by technology).
The current monetary system at its core is debt based; the reserve asset is US Treasuries; which doesn’t have a real cost to produce. Economists know that debt based monetary systems requires an exponential increase in debt (including US treasuries) to stay stable, and this biases the system to generate and require inflation.
The federal reserve has many powers, but switching the reserve asset of the monetary system is not one of them, only the political branches can decide what is the reserve asset of the US / international monetary system — see Bretton Woods, Nixon and the gold window.
We are arguing different things. You are arguing that a slow, steady rate of inflation has advantages. I am arguing that is not the Fed’s charter.
Perhaps the Federal Reserve’s charter should be changed.
Dave Schuler: I am arguing that is not the Fed’s charter.
The charter says “stable prices”. Zero percent inflation is inherently unstable, sometimes even dangerous.
Congress did not mandate a specific rate of inflation, but did grant the Federal Reverse independence to “promote effectively” their not always consistent goals. The Federal Reserve therefore defined stable prices as when people don’t have to worry about significant long-term changes in pricing, in other words, moderate and predictable.
That is an argument that the charter should be changed; I agree.
Dave Schuler: That is an argument that the charter should be changed
Not sure why you say that? They have the flexibility to set a standard based on economic understanding. It allows them to change policies as the situation changes or as understanding increases. What would you change it to?
Even a charter change won’t produce stable prices because the toolset (interest rates) the Federal Reserve has to achieve its mandate doesn’t include what is needed (changing the reserve asset of monetary system).
I am not arguing against stable prices, but it does require tradeoffs. We can study history from periods where the US had stable prices (from the independence to Great Depression / WWII, with the exception of civil war and WW1). Generally, economic cycles were more volatile, greater booms and greater busts, and no ability for governments to “boost” the economy or do counter-cyclical fiscal policy, but the cycle was shorter. Fairly frequent bank runs. A commitment to no major wars (every major war has created high inflation) — in practice a policy of isolationism. No sustained trade deficits, and by implication trade is managed through tariffs.
Seems like Dave is just being pedantic about the phrasing of the charter. Maybe he just needs to feel superior to someone.
I mean, he could just read how the Fed defines it.
“Price stability means that inflation remains low and stable over the longer run.”
https://www.stlouisfed.org/in-plain-english/the-fed-and-the-dual-mandate
It’s not that. Zachriel and I differ on how we think laws should be treated. I think they should be a ceiling not a floor.
Dave Schuler: I think they should be a ceiling not a floor.
The target is 2% over the long run. That means when inflation is above that amount, they consider actions to lower it—not precipitously, because then it could cause instability. And if it goes above your ceiling, then what? Should they act precipitously? Throw their hands up? Or should they do what they do now and consider the overall effect of their policies, even while attempting to bring down inflation to the target zone?
Note CuriousOnlookers comment that the toolkit the Fed has may not always be sufficient. Not only is the toolkit limited, but there are all sorts of events that can cause economic disruption that are outside their control (e.g. pandemics, bank runs, Trump acting insane).
I think the Fed’s current interpretation is a corruption of the ordinary meaning of the term “price stability”. Anyone until 1940 would have understood price stability as relating to the price level, not the first derivative of the price level.
The Richmond has a good essay on the history of the dual mandate (https://www.richmondfed.org/publications/research/economic_brief/2011/eb_11-12).
This (https://www.stlouisfed.org/publications/regional-economist/second-quarter-2017/a-short-history-of-prices-inflation-since-founding-of-us) by the St Louis Fed is actually a pretty good overview of prices and inflation over the past 250 years. Figure 1 is the most meaningful, it shows the price level but in logarithmic terms, so 1 = price level has increased by 10, 2 = price level has increased by 100, etc). Its remarkable that in 1910, prices were the same as 120 years earlier when the Federal Government was established in 1790. Ever since then, prices have increased roughly by an order of ~5000. Coincidentally, 1913 was the Federal Reserve act, 1914 was WW1 and the end of the gold standard, 1940 was WW2, and 1970 was the abandonment of the dollar standard (any tie of the monetary system to gold, those are all inflection points in figure 1. The moderation of inflation from 1980-2020 is barely visible on the graph.