Inflation Cure is Medical Malpractice

by Ramesh Ponnuru

James Pethokoukis writes much with which I agree in his home-page piece today: Inflation right now is running low; the rising prices that concern consumers are not in any important sense the result of Fed policy; “the Fed should explicitly and publicly target the level of nominal spending in the economy, or nominal GDP.” Yet I don’t agree with his conclusion that right now, higher inflation is “the correct economic fix.”

In the long run, a nominal-spending target is compatible with any desired level of average inflation. If trend growth is 2.5 percent a year and you want 2 percent inflation on average, target nominal spending at 4.5 percent. You don’t need to raise average inflation to gain the advantages of stabilizing the path of nominal spending (such as more predictable debt burdens and the ability to vary inflation around the average to mitigate the effect of supply shocks).

In the short run, Pethokoukis doesn’t really want more inflation; he wants higher growth in nominal spending and income. And he’d prefer as much of that nominal growth to be real, and as little of it to be inflation, as possible. He writes that the ”expectation of higher nominal growth and higher inflation would boost both consumer and business spending.” It’s true that expectations of higher inflation have this effect, but so do expectations of higher real growth. In other words, it’s the expectation of higher nominal growth that’s doing all the work.

Higher inflation should neither be the goal nor the means of monetary policy even in the short run; at most it’s an acceptable byproduct of monetary policy in some situations. 

If advocates of a nominal-spending rule for the Fed don’t have any reason to desire higher inflation, and calling for higher inflation is bound to be unpopular, then why do it? I think the answer is that we shouldn’t.