Let’s tolerate a little inflation, says economist

The Fed doesn't want inflation to rise to 2.5 percent or 3 percent, even temporarily. But economist Laurence Ball says there is little evidence that inflation even as high as 4 percent would significantly harm the economy—and would be a small price to pay for the resulting sustained jobs gains. (Credit: Camil Tulcan/Flickr)

The Federal Reserve should extend recent dramatic job growth by keeping US interest rates near zero and tolerating a little inflation, argues economist Laurence Ball.

By the end of 2015, forecasters say, the United States could hit the Fed’s definition of “maximum employment”—with an unemployment rate of roughly 5.2 to 5.5 percent. With this jobs goal in sight, the Fed is expected to begin raising interest rates to try to avoid overheating the economy and triggering inflation.

By holding off on interest rate hikes, however, Ball suggests, the central bank could drive the unemployment rate “well below 5 percent”—and bring even the long-term jobless back into the workforce.

‘High-pressure’ economy

“If policymakers would accept a modest overshoot of their inflation target, they could do more to reverse damage from the Great Recession,” writes Ball in a paper published by the Center for Budget and Policy Priorities. “If a recession leaves workers discouraged and detached from the labor force, a high-pressure economy with plentiful job opportunities could draw them back in.”

Such a “high-pressure” economy would likely cause only “modest and temporary” violation of the Fed’s inflation target and “any adverse effects would be slight compared to the gains in employment and output,” Ball says.

Recent US job growth has been good. The unemployment rate dipped in February and March to 5.5 percent, the lowest since before the 2008 financial crisis and well below the 10 percent recorded in October 2009, just after the recession ended and recovery began.

Also in February, the total of US nonfarm jobs rose by 295,000, with an average increase of 266,000 the prior 12 months, according to the Bureau of Labor Statistics. BLS reported a weaker gain of 126,000 jobs in March.

Missing jobs

Ball, professor of economics at Johns Hopkins University and a former visiting scholar at the Federal Reserve, contends that accepting an unemployment rate of 5.2 percent and an inflation rate of 2 percent, while safe and conventional, is not optimal policy for the United States right now.

To begin with, he says, the improving unemployment rate masks considerable persisting damage from the recession. Because unexpectedly large numbers of workers stopped even looking for jobs, and haven’t returned to the labor force, and still more workers are involuntarily working part-time, “millions of jobs lost during the Great Recession are not coming back in the return to normalcy envisaged by the Fed,” says Ball, who is also a research associate at the National Bureau of Economic Research.

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“Today we are left with short-term unemployment near its natural state,” Ball writes, “but with a legacy of long-term unemployment and non-participation that will persist if policy is not sufficiently expansionary.”

The Fed doesn’t want inflation to rise to 2.5 percent or 3 percent, even temporarily. But Ball says there is little evidence that inflation even as high as 4 percent would significantly harm the economy—and would be a small price to pay for the resulting sustained jobs gains.

“The Fed should do everything it can to promote a high-pressure economy,” he writes, “not increase interest rates and choke off growth as soon as inflation threatens to rise.”

Source: Johns Hopkins University