MNI INTERVIEW: Fed Should Raise Inflation Target To 3%-Gagnon

Federal Reserve officials should consider raising their inflation target to 3% from 2% in order to keep the economy humming without needlessly raising unemployment, Joseph Gagnon, a former Fed board economist who has long advocated such a change, told MNI.

“I am interested by the upcoming framework review and whether a change in the target will be taken off the table as before,” Gagnon said. Fed Chair Jerome Powell “explicitly said in December that a change in the target could be something to revisit in the longer term and I would think the five-year review may be that time.”

MNI reported in June that central bank policymakers would likely consider moving to a less pinpointed inflation target band, potentially ranging from 1.5% to 2.5%, in their upcoming framework review.

Gagnon noted such deliberations, while not set to be unveiled until 2025, are likely to begin in earnest in 2024.

“The review should start early next year though it might last up to 12 months as it did last time. Hopefully could be faster,” said Gagnon.

The Fed this week left interest rates on hold but penciled in one additional rate hike for this year while halving the expected number of rate cuts for 2024 to two from four.

A 'CRIME' TO CAUSE RECESSION

However, Gagnon suggested the soft-landing scenario would become far less likely if the Fed is a stickler for bringing inflation, 3.3% in the year to August, all the way back down to 2%.

“With such a strong labor market and wage growth, there is a strong possibility they may need to hike a lot more next year and beyond if they really want to get back to 2. It would be a shame to do so given all the arguments that 2 is too low, especially if they could easily stabilize at 3,” he said. (See MNI INTERVIEW: Resilience Calls For More Fed Tightening - Tracy)

Yet Gagnon acknowledged that it would be easier to raise the inflation target from a position of strength – that is, having already declared victory on hitting 2%.

“I think inflation persistently above 3% or below 3% but expected to rise again because of wage pressures would force them to hike again and postpone any target change,” he said. “But I would hope that inflation stably in the 2-3% range would not be a bar to changing the target. It would be a crime to cause a recession in that scenario.”

Proponents of a higher inflation target like Gagnon argue that it would lessen the chances the Fed will again hit the zero lower bound on rates in the future, and then have to resort to unconventional monetary policy such as asset purchases.