In the wonky world of economic policy analysis, old fallacies seldom die. Consider the following passage in this week’s Morning Money, discussing the failure of the Fed’s flexible average inflation targeting (FAIT) framework:
But the [FAIT] policy was designed for an economy that doesn’t resemble the pandemic‐era world—one in which inflation increased based on healthy economic factors, including plentiful jobs, bolstered by economic growth, that pushes up wages as well as prices.
Whatever the merits of FAIT, the idea that healthy economic growth causes inflation is as barmy as it is enduring.
It happens that my colleague, George Selgin, has been trying to put this delusion to rest for decades. In his 1997 book Less Than Zero, for instance, he explains that the more output an economy generates, the cheaper things tend to get, other things equal. In other words, if inflation is more money chasing fewer goods, healthy economic growth is more goods chasing the same amount of money.
What’s more, Selgin shows that the sort of deflation healthy growth causes can itself be perfectly healthy: unlike deflation caused by a lack of demand, it doesn’t mean that anyone has to earn less. It just means that the money they earn buys more stuff. (For additional explanation, see here, here, here, here, and here.)
If it sometimes makes sense for central banks to “see through” inflation because events like COVID and the war in Ukraine reduce economic output, it makes just as much sense to see through occasional below‐average inflation, if not outright deflation, in good times.
These points aren’t just academic. The mistaken view constantly pushes the debate over optimal monetary policy in the wrong direction, leaving all sides without a clear path toward better policy.
Let’s hope it won’t take another 20‐plus years to get members of Congress to admit that price stability should not be the Fed’s mandate. Given our fiat money system, it would be far better to require the Fed to target stable total nominal spending, thus allowing the price level to fluctuate as appropriate, based on the broader economic circumstances.
We’d still need many other financial reforms to get the most out of economic freedom, but this shift would likely make those easier to implement.
