[ The Fed’s pursuit of its 2% inflation target will slow
economic growth, repress wage gains, make almost everyone’s job less
secure, and put us at risk for a recession.]
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THE FED’S 2% INFLATION TARGET – GOOD FOR THE RICH, NOT THE REST
OF US  
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John Miller
May 2, 2023
Dollars & Sense
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_ The Fed’s pursuit of its 2% inflation target will slow economic
growth, repress wage gains, make almost everyone’s job less secure,
and put us at risk for a recession. _

,

 

At his February 2023 press conference, Jerome Powell, the chair of the
Federal Reserve Board, announced that the Fed had raised short-term
interest rates for the eighth time since March 2022. The Fed boosted
the Fed Funds rate on overnight lending by commercial banks by a
quarter of a percentage point to 4.75%, its highest rate in 15 years.
The Fed’s move in turn pushed up other interest rates, including
mortgage rates, business loan rates, and new car loan rates.

 

Powell began his remarks by letting us know that he and his colleagues
on the Fed committee that voted in February to increase the Fed funds
rate feel the pain we’ve endured under the “hardship of
inflation.” He then promised that they remain “strongly
committed” to bringing inflation back down to the Fed’s 2% target
rate. And he assured us that the Fed’s pursuit of price stability
will allow for “a sustained period of labor conditions that benefit
all.”

Powell must have felt better after getting all of that off his chest.
But you shouldn’t. The Fed’s pursuit of its 2% inflation target
will slow economic growth, repress wage gains, make almost
everyone’s job less secure, and put us at risk for a recession.

Nor is there reliable evidence that the Fed’s policy of raising
interest rates to push inflation rates down to the Fed’s 2%
inflation target will promote economic growth even over the long term.
What is clear, however, is that the Fed’s monomaniacal pursuit of
its 2% inflation rate will widen the difference between the rich and
the rest of us. This target will protect corporate profits and stock
market returns while undermining the conditions that are necessary for
the “sustained period of labor conditions that benefit all” that
Powell promises.

What’s below endeavors to explain the conflict between the belief of
the Fed—and of most establishment economists—that the Fed’s
monetary policies ultimately provide widespread benefits, and the
empirical evidence that, in practice, the Fed’s monetary policy
exacerbates inequality as it keeps a lid on sustained economic growth
that could empower those who work for wages.

A Dubious Target

The inflation story of 2022 was a tale of two quite different
inflation rates. The Consumer Price Index (CPI), the most widely
reported measure of inflation, rose at a 2.8% annual rate from June
through December 2022, far less than the 10% CPI annual inflation rate
for January through June 2022. The monthly inflation rate picked up
some in January 2023. But the CPI inflation rate still averaged just a
3.3% annual rate from July 2022 through January 2023. (See Arthur
MacEwan, The Inflation Reality and the Attack on Wages
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on the 2022 inflation rates.)

Despite the dramatic drop in the inflation rates, which Powell
begrudgingly acknowledged as “a welcome reduction in the monthly
pace of increases,” in February the Fed once again raised interest
rates. The interest rate hike was intended to slow spending and
economic growth, which in turn would slow job creation and keep wage
gains in check. And in the wake of the January inflation figures, the
presidents of the Cleveland and St. Louis Federal Reserve Banks were
already publicly lobbying the Fed for larger interest rate increases,
of one-half a percentage point or more.

Nor is the Fed alone in its pursuit of a 2% inflation target. The
central banks of Australia, Canada, the euro area, Japan, and the
United Kingdom also operate with a 2% inflation target. (See below)

In their paper presented at the December 2022 Political Economy
Research Institute (PERI) conference on “Global Inflation Today,”
economists Robert Pollin and Hanae Bouazza found “no serious body of
research” that justifies a 2% to 3% inflation target. In their own
research, Pollin and Bouazza examined the relationship between
inflation rates and economic growth (corrected for inflation) of 130
countries at all levels of economic development from 1960 to 2021.
They show that during years that the inflation rates in these
countries were near the Fed’s 2% target these economies grew more
slowly than during years with somewhat higher inflation rates. For
their full 130-country sample, in years when inflation rates were less
than 2.5% (and greater than 0%) the median (or middle) growth rate was
lower than that during years with inflation rates between 2.5% and 5%,
as well as during years with inflation rates between 5% and 10%. The
same result held for a group of 37 high-income countries. During the
same time period, in the U.S. economy the median growth rate was 2.7%
a year when the inflation rate was between 0% and 2.5%. The median
growth rate in the U.S. was 3.6% for the years when the inflation rate
was between 2.5% and 5.0%, and it was 3.1% in years with inflation
rates between 5% and 10%.

Their empirical evidence shows that the Fed’s 2% inflation target is
associated with slowing down, not speeding up, economic growth. And
slower growth moves us further away from, not closer to, economic
conditions that could provide widespread sustained benefits.

A Wealth-Protection Racket

Powell and his colleagues might well believe that the Fed’s 2%
inflation rate will create widely shared economic benefits. Economic
policymakers that see the economy through “finance-colored”
glasses, as economist Jane D’Arista once put it, and whose primary
constituents are banks and financial institutions, might well see the
benefits of an inflation-obsessed monetary policy as widespread.

But, in practice, a 2% inflation rate target acts first and foremost
to protect the wealth of the rich from being eroded by inflation. In
their paper presented at PERI’s December 2022 conference on global
inflation, economists Aaron Medlin and Gerald Epstein argue just that.
To make their case, they document the close relationship between the
wealth gains of the richest 1% and 10% of households in the United
States and inflation rates. (Wealth includes financial assets, e.g.,
bonds or stocks, and nonfinancial assets, such as a house, a business,
or a car, minus debt, corrected for inflation.) In high-inflation
periods such as the 1960s and 1970s, the wealth holdings of the top 1%
stagnated, but then grew substantially in the next four decades,
increasing by an average of more than fourfold (corrected for
inflation) from 1980 to 2022.

Beyond that, Medlin and Epstein unravel how Fed policies intended to
lower inflation rates, by raising interest rates and slowing economic
growth, can protect the value of large wealth holdings. Fed policies
dramatically reduced but didn’t eliminate the damage that would be
done to the wealth of the top 1% (and the top 10%) with continued high
inflation rates. Higher interest rates decrease the market value of
long-term securities. Higher interest rates also reduce borrowing to
buy financial assets, which decreases the demand for and price of
stocks and bonds. At the same time, higher interest rates slow the
economy, dampening the outlook for future profits.

Nonetheless, Medlin and Epstein estimate that if the Fed had sat on
its hands and done nothing to bring down the high inflation rates, the
damage to wealth holdings would have been even greater and lasted
longer. In their study they found that a 6% inflation rate would have
reduced the value of the wealth holdings of the top 1% by 30% over
three years, since higher inflation rates would erode their value.
TThat was nearly twice the damage that would have been done by a 16%
reduction to their wealth holdings if the Fed had lifted interest
rates by 3.75 percentage points. Their study suggests that for every
percentage point the Fed increased interest rates, the inflation rate
would fall by 2% in three years’ time.

With those kinds of policies, the Fed has widened the difference
between the wealth of the rich, who own an outsized share of financial
assets and other forms of wealth, and that of most people, who
struggle to hold on to assets worth more than what they owe.
Inflation, when associated with a tight labor market as is usually the
case, empowers workers to push for wage increases. Employers are faced
with constant demands, exemplified by strikes and quits. By pushing up
interest rates, the Fed slows economic growth and job creation, costs
workers their jobs, and brings wage gains to a halt. With inflation
tamed and rising labor costs beaten back, profit margins are restored,
and the owners of capital and the investment class can enrich
themselves anew. So, yes, higher interest rates harm the wealthy, but
this is a short-run harm. Over the long term, workers are kept in
their place by the Fed’s inflation policy that “throws people out
of work as a wealth protection device for the top 1%,” as Medlin and
Epstein contend.

Growing Doubts About the 2% Inflation Target

Recently, even establishment economists are expressing their doubts
about a 2% inflation target. Olivier Blanchard, a senior economist at
the budget-balancing Peterson Institute, has pushed for an inflation
target of about 3%. So has economist Ken Rogoff, who thinks that the
Fed has already in practice adopted a 3% inflation target. Then, in a
January 2023 paper, staff economists Randal Verbrugge and Saeed Zaman
at the Federal Reserve Bank of Cleveland estimated that a deep
recession would be necessary to achieve the Fed’s target of
sustained 2% inflation. The recession would cause unemployment rates
to rise to 7.4% for two years.

Surely when researchers at the Fed are warning of the disastrous
consequences of pursuing its 2% inflation target, it is time to change
course and push for policies that would actually help us, in
Powell’s words, “achieve a sustained period of labor market
conditions that benefit all.”

_[JOHN MILLER is a professor of economics at Wheaton College and a
member of the Dollars & Sense 
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SOURCES:Aaron Medlin and Gerald Epstein, “Federal Reserve
Anti-Inflation Policy: Wealth Protection for the 1%,” Global
Inflation Today, Political Economy Research Institute, Dec. 2, 2022
(peri.umass.edu); Robert Pollin and Hanae Bouazza, “Considerations
on Inflation, Economic Growth and the 2 Percent Inflation Target,”
Global Inflation Today, Political Economy Research Institute, Dec. 2,
2022 (peri.umass.edu); Randal Verbrugge and Saced Zaman, “Post-COVID
Inflation Dynamics: Higher for Longer,” Federal Reserve Bank of
Cleveland, Jan. 13, 2023 (clevelandfed.org); Neil Irwin, “Of Kiwis
and Currencies: How a 2% Inflation Target Became Global Economic
Gospel,” _New York Times_, Dec. 19, 2014 (nytimes.com).

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The Kiwi Inflation Target Goes Viral

The 2% inflation target came into being with little or no theoretical
or empirical justification. Facing a 10% inflation rate in the late
1980s, New Zealand’s Finance Minister Roger Douglas told a
television interviewer that the government would set an inflation
target of zero to convince the public that its anti-inflation measures
would persist. The next year, with the opposition leader hospitalized
and Christmas around the corner, parliament made a zero to 2%
inflation rate the official target of the Reserve Bank of New Zealand.
In the mid-1990s the Fed and other central banks began to adopt New
Zealand’s 2% inflation target with little more economic
consideration than Douglas had given the target to begin with.
Nonetheless, a 2% inflation target was to their liking. It was
compatible with what most economists learned in graduate school, as I
did, about how lowering inflation rates would not reduce economic
growth over the long run. And a 2% inflation target was low enough to
please the Fed’s constituents, banks and financial institutions, but
not so low as to flirt with deflation and declining prices, which
would damage the economy.

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_This article is from the March/April 2023 issue of Dollars & Sense
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* inflation
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* federal reserve
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* interest
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* interest rates
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* Consumer Price Index
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* CPI
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* Economic Growth
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* wealth
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* recession
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