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Stop Inflating the Inflation Threat

Given the scale and severity of inflation in America in the 1970s, it is understandable that US monetary policymakers developed a deep-seated fear of it. But, nearly a half-century later, the conditions that justified such worries no longer apply, and it is past time that we stopped denying what the data are telling us.

BERKELEY – In light of current macroeconomic conditions in the United States, I’ve found myself thinking back to September 2014. That month, the US unemployment rate dropped below 6%, and a broad range of commentators assured us that inflation would soon be on the rise, as predicted by the Phillips curve. The corollary of this argument, of course, was that the US Federal Reserve should begin rapidly normalizing monetary policy, shrinking the monetary base and raising interest rates back into a “normal” range.

Today, US unemployment is 2.5 percentage points lower than it was when we were all assured that the economy had reached the “natural” rate of unemployment. When I was an assistant professor back in the 1990s, the rule of thumb was that unemployment this low would lead to a 1.3 percentage point increase in inflation per year. If this year’s rate of inflation was 2%, next year’s would be 3.3%. And if unemployment remained at the same general level, the inflation rate the following year would be 4.6%, and 5.9% the year after.

But the old rule of thumb no longer applies. The inflation rate in the US will remain at about 2% per year for the next several years, and our monetary-policy choices should reflect that fact.

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