Time for a Price Level Target, and a Damned High One!

If you believe in a NAIRU, or anything remotely like a NAIRU or an accelerationist Phillips curve, the prognosis for prices is looking increasingly ugly. For those who believe confidently in such a Phillips curve and accept historical estimates of the parameters, deflation is now a certainty, and severe deflation is a strong possibility. Even among those who don't believe in a Phillips curve, deflation should be considered at least a serious possibility, and the danger of a deflationary spiral should not be ignored.

It's time to stop worrying about policies that "may cause inflation in the long run" and to embrace such policies specifically because they may -- and hopefully will -- cause inflation. Markets are desperately in need of "shock and awe," and the Fed can provide that shock by setting a long-run price level target much higher than anything previously considered reasonable. I would recommend a target representing an average rate of inflation of 6% over the next 5 years and 5% over the subsequent 5 years. The Fed could also set longer range price targets that represent lower inflation rates thereafter (assuming the earlier targets are achieved): say 4% from 2019 to 2024 and 3% thereafter. (Experience has now made clear that 2% was too low -- too close to zero -- for a long-run target during normal times.)

The point of using price level targets is that, the worse things get, the more inflation the Fed will promise for the future. And the more inflation it promises for the future (assuming markets believe those promises), the lower will be longer term real interest rates at any give level of nominal rates. If the Fed can induce such an expectation, it will then be able to provide a more dramatic stimulus at just the right time by setting real rates that are significantly negative. (If necessary, the Fed can set longer-term real rates by buying sufficient quantities of longer term securities, or by having the Treasury retire such securities.)

Again, "dangerous policies" that "may be highly inflationary in the long run" are just the policies that our leaders should be embracing at this moment, precisely because those policies may -- and hopefully will -- be inflationary in the long run. So if the Fed buys lower quality securities on which it risks having to take losses, let it say, "It is our great hope, in the event that economic weakness prevents the price level from approaching our target, that we may have the opportunity to take large losses on these securities and to make up those losses by creating more base money. Only by taking such losses can we implement the 'helicopter drop' that may be necessary." And if the Fed should expand the monetary base dramatically in the hope of encouraging bank lending, and detractors should argue that this policy is reckless because the Fed will need to withdraw that money later to prevent inflation and may not be willing to do so, let the Fed respond, "It is not our intention to withdraw that money later, unless the price level should threaten to rise significantly above our target. Should the inflation rate over the next few years prove too low, it is our intention to resist steadfastly any pressure to avoid the very high inflation rates that will then be necessary to achieve our target."

Let's be quite clear about the arithmetic here. If the average inflation rate over the next 5 years should be zero -- which in the absence of policies such as those I advocate above, would be a very reasonable forecast, and in the presence of such policies would still not be an unreasonable one -- the Fed will of course miss its 5-year target by a dramatic margin. But the 10-year target will remain. The arithmetic would then require an 11% inflation rate over those next 5 years, in order to meet that target. That is the promise that the Fed must make for the future in order to achieve the vital goal of producing very low real interest rates today. And as for those who say that 11% is too much, even if they be 99% of the population, to my mind they are all traitors, enemies of the United States and of the world, and if I had my way, they would all be hanged!

Their intentions are good, perhaps, but we must not let such foolishness lead us down the road to Hell.