Central bankers – we are told – must battle deflation risk today at all costs because deflation slows growth, and may cause recessions and financial system collapses. I agree with the view that the Fed should be targeting an announced long-run rate of inflation. And so, I agree that monetary policy should seek to avoid sustained deflation or very low inflation as part of its inflation targeting commitment. But that is not the same as believing that a short-run deviation from 2% inflation would pose a severe economic risk – especially if it were a consequence of actions that better ensured adherence to the long-run 2% target. In particular, given the significant inflation risk associated with exiting from the Fed’s QE3 policy, beginning to scale back the Fed’s portfolio of long-maturity mortgage-backed securities and government bonds would be appropriate.
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Stop Worrying About Deflation
Central bankers – we are told – must battle deflation risk today at all costs because deflation slows growth, and may cause recessions and financial system collapses. I agree with the view that the Fed should be targeting an announced long-run rate of inflation. And so, I agree that monetary policy should seek to avoid sustained deflation or very low inflation as part of its inflation targeting commitment. But that is not the same as believing that a short-run deviation from 2% inflation would pose a severe economic risk – especially if it were a consequence of actions that better ensured adherence to the long-run 2% target. In particular, given the significant inflation risk associated with exiting from the Fed’s QE3 policy, beginning to scale back the Fed’s portfolio of long-maturity mortgage-backed securities and government bonds would be appropriate.
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