US risks a surge in inflation

published 23 July 2020

The US Federal Reserve might be ready to push inflation above the 2% target, reports Tim Duy on Bloomberg. The last decade brought low unemployment and low inflation, weakening faith in the “Phillips curve”, which posits a trade-off between the tightness of the labour market and price stability. Several Fed policymakers have recently suggested that instead of trying to use the curve to predict future inflation, the Fed should simply keep money easy until actual inflation overshoots the 2% target.

US inflation has practically disappeared in the slump, but the vast monetary stimulus unleashed to fight the pandemic has raised the spectre of higher inflation when the recovery arrives. The Fed’s balance sheet has grown from about $4trn at the start of the year to $7trn today because of pandemic-related stimulus.

Fed policymakers are probably right that the Phillips curve has “lost much of its predictive value”, writes Andrew Stuttaford in National Review. In a world of weaker trade unions and automation, even when unemployment is low, wages do not rise much. Yet the Fed is underestimating the damage that ultra-low interest rates can do, from weakening pension funds to creating an incentive for vast amounts of ill-judged investment across the economy. And history shows that when inflation goes over target it can be more difficult to rein it back in than people think. “I doubt this ends well.”