Should you worry about the rate of price inflation being too high?

Of course you should worry, not withstanding all of the dogmatism on Twitter and the pre-Lucasian framing of various charts and graphs.

Here is a simple way to look at it.  Let’s say the Fed does the very best job possible with its monetary policy (and in my view the Fed has done a very good job so far).  That would mean in terms of the loss function a Fed error in one direction would mean a too low rate of price inflation, and a Fed error in the other direction would mean a too high rate of price inflation.

Now, supply conditions have never been so volatile in my lifetime, and perhaps never in American history.  We don’t know how the virus will spread, how reopenings will go, when a vaccine will arrive, how good the vaccine will be, how much a climate of fear will persist, and so on.  Demand conditions in turn depend on how these supply conditions will evolve.

The Fed thus could make an error on either side of its target, through no procedural fault of its own. As a result, as a simple matter of logic, the rate of price inflation could be too high, or it also could be too low.

if you think you know the direction of the error in advance, you aren’t paying enough attention to the underlying unpredictable uncertainties.

And if your response is to cite old open letters to the WSJ and the like, that is the same dogmatic error that the inflation hawks from the 1970s have been making.

There are other, more substantive arguments why the rate of price inflation might end up too high (the fiscal side really matters!), but that is the simplest one and you won’t see it on Twitter.  And it is fine to argue, by the way, as does Matt Yglesias, that you would rather see it too high than too low.

I was glad to see Martin Wolf tackle this whole question (FT) and not be too scared off by the yappers.


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