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+1 vote
asked ago in General Economics Questions by (360 points)
In 2012 under Ben Bernanke, the Fed publicly announced that their inflation target would be at 2%, which was already for some time the informal target rate.

But today the FOMC believes the long-term natural funds rate to be at about 3-3.25%. Given that in the past three recessions the Fed lowered rates by an average of 5.79%, this is not enough "ammunition" to combat the next recession.

Some economists have argued to change the target rate to 4% (Ball, 2014), and others have argued for other methods like setting a targeted range of inflation rates (Ed Rosengren, Boston Fed president) while others still have proposed a price-level targeting framework rather than an inflation-rate targeting framework (John Williams, SF Fed president).

Is a change necessary in the long-term? What possibilities should be explored?

2 Answers

+1 vote
answered ago by (930 points)
edited ago by
My opinion is that inflation is down because corporate profit rates are at record highs. Corporations do not need to raise prices. Capacity utilization is low also because labor share is down. So even if the Fed wanted a 4% inflation target, in this environment they wouldn't reach it.
My model sees a 3% inflation as more reasonable than a 4% target.

Here is a post of my model from November, 2016. The model is still holding true.
http://effectivedemand.typepad.com/ed/2016/11/inflation-as-mouse.html

Here is another post of mine on inflation targets using the same model from July, 2016.
http://effectivedemand.typepad.com/ed/2016/07/3-inf-target.html
+1 vote
answered ago by (260 points)
A big question with no definitive answer... your views will to some extent depend on whether you think the costs of a 4% steady state inflation rate are significantly higher than those associated with 2%, and there's not a whole lot of evidence on the costs of inflation in this range. There's also the possibility of nominal GDP targeting, which has a certain logic - Larry Summers has been making the case of late.
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