On the Economy: Fed Needs to Keep Its Eye on the Price-Stability Ball

By at 14 August, 2019, 12:19 pm

by Raymond J. Keating-

As we’ve seen a variety times over recent decades, the Federal Reserve can get distracted, or even lost in visions of grandeur, forgetting what the true job of a monetary authority is.

The lone job that the Fed is fit to do is to work to maintain price stability. That usually means making sure that the inflation genie does not escape the bottle and unleash a tax on consumers and investors. Keep inflation low and the dollar stable – that’s about it for the Fed. Or at least, that’s about all it should be.

But what about the Fed’s dual mandate – the goals of maximum employment and stable prices, as imposed by Congress in 1977? That’s easy. Given that the Fed is, again, a monetary authority, the only contribution that the Fed can make toward a goal of maximum employment is maintaining stable prices.

When the Fed takes its eye off the inflation ball, and starts playing games with trying to juice up the economy through loose money, for example, no real boost to economic growth materializes. The most obvious example of this was the Fed’s unprecedented expansion of the monetary base from 2008 to 2015, while the U.S. suffered through the Great Recession and a miserable subsequent recovery period. The best case scenario when the Fed wanders away from a focus on price stability is increased uncertainty in the marketplace.

Understanding what the Fed is supposed to be doing, the latest Consumer Price Index report pointed to inflation running at 0.3 percent in July. That’s a substantial increase over the 0.1 percent prevailing in both May and June.

Hopefully, the July number was just a temporary spike – as inevitably occurs here and there in the CPI data – and not something more. As noted in Chart 1, one must ask: Which trend might continue – the low inflation that held in May and June, or the higher inflation running in March, April and July?

Chart 1: Change in the Consumer Price Index, July 2018 to July 2019

Source: Federal Reserve Bank of St. Louis, FRED

Again, making sure that inflation does not step up should be the Fed’s focus. It shouldn’t be succumbing to misguided political pressure to cut interest rates and run even looser monetary policy. After all, the idea of an independent monetary authority is to avoid the ills of politicians misusing monetary policy for assumed short-term gains. Those gains, by the way, never materialize, with misguided policies only creating more economic woes.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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