Paul Krugman: No inflation bogeyman for US Fed to fret about
Interest rate increase could cost economy millions of jobs and trigger deflationary trap
The United States is now adding jobs at a rate not seen since the Clinton years. Photograph: Bryan O’Brien/The Irish Times
Six years ago, Paul Ryan, who has since become the chairman of the US House Ways and Means Committee and the GOP’s leading voice on matters economic, had an op-ed article published in The New York Times. Under the headline “Thirty years later, a return to stagflation”, he warned that the efforts of the Obama administration and the US Federal Reserve to fight the effects of financial crisis would bring back the woes of the 1970s, with both inflation and unemployment high.
True, not all Republicans agreed with his assessment. Many asserted that we were heading for Weimar-style hyperinflation instead.
Needless to say, those warnings proved totally wrong. Soaring inflation never materialised. Job creation was sluggish at first, but more recently has accelerated dramatically. Far from seeing a rerun of that Seventies show, we’re now looking at an economy that in important respects resembles that of the 1990s.
To be sure, there are big differences between the US in 2015 and the US in the 1990s. TV is much better now; the situation of workers much worse. While stocks are high and there is talk of a new technology bubble, there’s nothing like the old euphoria. There is also, unfortunately, no sign that the great productivity surge of 1995-2005 – brought on as businesses adopted information technology – is coming back.
But pointing out, yet again, just how wrong the usual suspects on the right have been about, well, everything isn’t the only reason to note parallels with the 1990s. There are also implications for monetary policy: recent job gains have brought the Fed to a fork in the road very much like the situation it faced circa 1995.
Now, as then, job growth has taken the official unemployment rate down to a level at which, according to conventional wisdom, the economy should be overheating and inflation should be rising. But now, as then, there is no sign of the predicted inflation in the actual data.
The Fed has a dual mandate – it is supposed to achieve both price stability and full employment. At this point, price stability is conventionally taken to mean low but positive inflation, at about 2 per cent a year. What does it mean to achieve full employment? For the Fed, it means reaching the the non-accelerating-inflation rate of unemployment, which is consistent with that inflation target.
The Fed currently estimates this rate at between 5.2 per cent and 5.5 per cent, and the latest report puts the actual unemployment rate at 5.5 per cent. So we’re there – time to raise interest rates!
Or maybe not. The non-accelerating-inflation rate of unemployment is supposed to be the unemployment rate at which the economy overheats and an inflationary spiral starts to kick in. But there is no sign of inflationary pressure. In particular, if the job market really were tight, wages would be rising quickly, whereas they are in fact going nowhere.
The thing is, we’ve been here before. In the early to mid-1990s, the Fed generally estimated the rate as being between 5.5 and 6 per cent, and by 1995, unemployment had fallen to that level. But inflation wasn’t actually rising. So Fed officials made what turned out to be a very good choice: they held their fire, waiting for clear signs of inflationary pressure. And it turned out the US economy was capable of generating millions more jobs, without inflation, than it would have if the Fed had reined in the boom too soon.
If it turns out that the Fed has waited a bit too long, inflation might overshoot 2 per cent for a while – that wouldn’t be a great tragedy. But if the Fed moves too soon, the US might end up losing millions of jobs it could have had – and in the worst case, it might end up sliding into a Japanese-style deflationary trap, which has already happened in Sweden and possibly in the euro zone.
What’s worrisome is that it’s not clear whether Fed officials see it that way. They need to heed the lessons of history – and the relevant history here is the 1990s, not the 1970s. Let’s party like it’s 1995; let the good, or at least better, times keep rolling, and hold off on those rate hikes. – New York Times News Service