“Opportunistic Disinflation”?? What the…?

Yglesias and TheMoneyIllusion link to sites explaining “opportunistic disinflation.” It’s a questionable doctrine adopted sometime in the 1980s by the Federal Reserve for fighting inflation “opportunistically.” It contrasts with what former Fed Chairman Paul Volker did in 1981—slamming 15% hyper-inflation with a Fed Funds rate of 19% and throwing the economy into deep recession with 10% unemployment.

Instead, the Fed waits for the “inevitable” recession, arising in the normal course of the business cycle, and takes advantage of its routine disinflationary effect. Then, at the first signs of inflation during a recovery, it preemptively begins a gradual tightening of credit and waits for the next inevitable recession to do the rest, with the aim of grinding inflation down as far as possible—without appearing to be actually doing all that much.

The trouble with this doctrine is that it says nothing about the other side of the Fed’s dual mandate: promoting full employment. Some Fed members today are voicing concerns about inflation but, right now, inflation is not the problem. Employment is.

CPI inflation is 3.8%, while core inflation, ex food & energy, is 2.0% (Figure 1):

CPI inflation and core inflation

Figure 1

It is core inflation that guides Fed policy, or an alternative like the Dallas Federal Reserve Bank’s “Trimmed Mean PCE Inflation Rate.” PCE is Personal Consumption Expenditures, a major component of GDP—in fact 70% of it (Figure 2):

Dallas FRB Trimmed Mean PCE Inflation Index

Figure 2

Some complain that a core or trimmed-mean index falsifies the “real” inflation rate, the rate everyone lives with. But that misses the point. You wouldn’t want the Fed to manage interest rates by lurching after the volatile all-items index. Look at the CPI whiplash in Figure 1, when oil prices spike in 2008, then immediately plunge during the recession in 2009. How would you make policy with that data?

Also, inflation these days is being pushed by factors out of our control. Emerging economies have boomed past the recession, raising market prices world-wide, and world food prices are at a 20-year high. Our own inflation, the inflation we’re actually producing, is weak by comparison. In fact, some added inflation right now might be good for the economy, because it would deflate the still large burden of debt and free up our productive potential.

Well, what about the Fed and the state of employment? Apparently an Occupy Wall Street demonstrator has the answer (via Paul Krugman).


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