For a good while now, every time a monthly jobs report comes out we all tend to hope it’s good, but not too good. If it’s too good, after all, the pressure on the Fed to hike interest rates in case inflationary pressures are about to explode will become overwhelming. But since some of the voices the Fed listens to think all seven deadly sins are inflation, it’s getting harder every month to hold off the pressure.
Today, and not for the first time, Paul Krugman has a simple enough proposal: why not wait until there are actual sings of actual inflation before putting on the brakes? After all, that’s what the Fed did in the mid-1990s, and it turned out to be a very wise decision:
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.
And in the 90s:
[I] turned out that the United States’ economy was capable of generating millions more jobs, without inflation, than it would have if the Fed had reined in the boom too soon.
Why not do the same thing now, when in addition to the 90s parallels, the economy is coming out of the worse recession since the 1930s?
To me, as to a number of economists — perhaps most notably Lawrence Summers, the former Treasury secretary — the answer seems painfully obvious: Don’t yank away that punch bowl, don’t pull that rate-hike trigger, until you see the whites of inflation’s eyes. If it turns out that the Fed has waited a bit too long, inflation might overshoot 2 percent for a while, but that wouldn’t be a great tragedy. But if the Fed moves too soon, we might end up losing millions of jobs we could have had — and in the worst case, we might end up sliding into a Japanese-style deflationary trap, which has already happened in Sweden and possibly in the eurozone.
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.
I might add that it seems a bit ironic that Larry Summers is publicly lobbying Janet Yellen for a more “populist” monetary policy. But perhaps she privately agrees, and is marshaling support for that same policy.