For over a year now, the Federal Reserve has been attempting to reduce inflation to its 2% target. Officials have raised interest rates faster than any of their predecessors to do this, and even after the second- and third-largest bank failures in U.S. history this monthwhich were caused at least in part by the aggressive rate hikesofficials plan to continue targeting that magical 2% figure.
We do have a mandate legislated by Congress and the President to maintain stable prices for the U.S. economy. Thats in the law, Federal Reserve Bank of St. Louis president James Bullard told Bloomberg Friday. Weve defined stable prices as 2% inflation. Thats an international standard that was developed in the 1990s. I think it would be a disaster to abandon that standard.
Bullard argued that if he and other Fed officials gave up their inflation fight, it would lead countries worldwide to the same, and we would be back to the 1970s. The roots of the so-called Great Inflation of the 70s are still debated today, but its widely accepted that a combination of President Lyndon B. Johnsons aggressive spending on the Vietnam War and Great Society social programs meant to alleviate poverty in the late 60s, along with spiking energy prices, loose monetary policies, and the end of the gold standard, combined to create a nightmare scenario for price stability. The runaway inflation was only curtailed after Fed Chair Paul Volcker came to power in 1979 and jacked up interest rates, sparking a double-dip recession.
Bullard admitted, however, that the Fed has made progress in stabilizing consumer prices this time around, and said he expects that to continue throughout the year. Year-over-year inflation, as measured by the consumer price index, dropped from its four decade high of 9.1% last June to just 6% in February. And the personal consumption expenditures (PCE) indexthe Feds favorite inflation gauge, which needs to drop to around 2% for officials to be happyfell to 5.4% in January. Februarys data will be released March 31.
But Bullard went on to say that he was concerned some of the recent decline in inflation came from falling energy prices, and those can be volatile, so you dont want to live and die on international commodity markets.
Still, fading inflation coupled with the banks recent instability has some experts wondering why the Fed believes they need to keep raising rates. And why their 2% inflation target is so special.
Starwood Capitals CEO Barry Sternlicht, for example, equated the Feds inflation-fighting rate hikes to using a steamroller to get the price of milk down two cents, to kill a small fly, in a Thursday interview with CNBC.
The billionaire has been making this argument for a while. Back in October, well before the collapse of SVB, Sternlicht told Fortune that the Feds aggressive interest rate hikes were apt to send the economy into a recession or create financial accidents. And he argued officials should consider rethinking their 2% inflation target altogether, too.
I think the number 2% is kind of arbitrary, he said. And could it be 3% or 4%? That would be fine.
And economist Mohamed El-Erian warned that the Fed wont be able to get inflation down to 2% without crushing the economy in an interview with Bloomberg Television last month. Thats because 2% is not the right target, he added.
But the Fed raised rates by 25 basis points this week despite its critics, reaffirming officials commitment to achieving the 2% inflation target, even if it means some pain for the economyas Powell famously said at the Jackson Hole Economic Symposium last August. And St. Louis Fed president Bullards comments Friday only reinforced that move.
