Don’t forget about inflation: It can sneak up on us

We spent a good part of the late 1960s to the early 1980s grappling with the scourge of rising inflation. Consumer prices rose from less than 2% in 1960 to 13% in 1980. There was a widespread fear that it would go higher. Various presidents tried different approaches, including mandatory wage and price controls. We need to be careful that we don’t accidently fall into the same trap.

On its face, this is an absurd statement. The double-digit inflation of the early 1980s was crushed by a deep recession engineered by then-Federal Reserve chairman Paul Volcker, with the crucial backing of newly elected President Ronald Reagan. Peak monthly unemployment reached almost 11%. Today, inflation is an afterthought. The crying need now is to reduce the huge pool of jobless workers receiving unemployment benefits, about 14.5 million or roughly a 10% unemployment rate.

We believe we’ve won the battle against high inflation. It’s one economic problem not worth worrying about. The staggering number of unemployed people will keep wages from exploding. Powell and others have argued that the Philips curve, which describes the relationship between wages and inflation, has flattened. Wage gains have a much weaker impact. Popular expectations of annual inflation over the next decade average a mere 1.34%, reports the Federal Reserve Bank of Cleveland.

All that is true — and it’s wildly misleading.

The Federal Reserve last week announced new guidelines for policing inflation and unemployment. The old policy established an inflation target of 2%. If inflation exceeded this level, the Fed would presumably raise interest rates to relieve upward pressures on wages and prices. Under the new policy, the Fed would tolerate slightly higher inflation levels temporarily rather than risk triggering a recession or economic slowdown.

Superficially, this seems a pragmatic response to balancing the risks of inflation and unemployment. But history sounds an alarm.

No one favored the inflation breakout; no one wanted it. The increases occurred in short and powerful bursts that fed on each other. What people did want was “full employment,” defined in the early 1960s as about a 4% unemployment rate. People were willing to suffer slightly higher inflation to keep wages high and unemployment low.

What seems remarkable now is that many, possibly most, economists blessed this arrangement. Their argument was that just a little bit more inflation was a small price to pay for sustaining “full employment.” The trouble was that “just a little more inflation” was repeated countless times until it was a lot more inflation and, as a practical matter, was out of control. Only the harsh Volcker-Reagan recession convinced companies and workers that high inflation would no longer be accommodated.

The Fed’s new inflation policy bears a striking resemblance to the flawed approach of the past. The Fed would tolerate breaking the 2% inflation barrier to the extent that actual inflation had been below 2% target for some specified period. But would the Fed then mechanically raise interest rates to quell inflation?

Even before the coronavirus pandemic, Fed Chair Jerome H. Powell had been eager to promote a tight labor market that would provide jobs for many lowskilled and low-paid workers, who traditionally have struggled to find employment. That goal was (and is) commendable, but for the time being it’s unrealistic.

We ought to remember that high inflation, when it raged in the 1970s and 1980s, was enormously unpopular. High inflation made planning for retirement harder; the future seemed unpredictable and precarious.

We don’t want to revisit this failure, which was political and social as well as economic.

The whole exercise of hitting a rate of inflation of 2% assumes that the Fed can control inflation and job creation with an exactitude that doesn’t exist. The best the Fed can do is to aim at a range of inflation — say, zero to 2% — and, when prices are moving undesirably in one direction or the other, respond vigorously to reverse course. It’s unheroic, but feasible.