Wall Street wants to raise the target inflation rate above 2%. This is not a surprise

The rate of price inflation in the United States has stayed high for a long time. In October, it was 7.7 percent. The Fed's favorite measure of inflation, which is called "core inflation," is only two-tenths of a percent below 40-year highs, at 6.3%. Still, the Federal Reserve and other "experts" were worried last year that inflation wasn't high enough. In January 2021, for example, Jerome Powell said that the Fed wanted price inflation to be above the "2% goal" because it had been below that level for too long. The 2-percent inflation target is, of course, just a number that the Federal Reserve (and many other central banks) chose at random as the "right" inflation rate.

Now that inflation is close to its highest level in 40 years, many people are wondering what it will take to bring prices back down to the target level. How many increases in the target interest rate will be needed, and how bad will the recession have to be? Wall Street cares a lot about the answer to this question because fundamentals no longer matter on Wall Street. Instead, the "market" is mostly affected by how much easy money the central bank gives out. The banker class wants to get back to "normal" as soon as possible, which means quantitative easing and very low interest rates. Also, Washington wants the same thing, because the political class wants low interest rates to make it easier for the government to keep borrowing more money and running deficits that keep getting bigger.

It's not surprising at all that people are already calling for the Federal Reserve to stop trying to keep inflation at 2% and instead accept even higher inflation rates that will never go down. For example, Ethan Harris, an economist at the Bank of America, said last week that the target CPI inflation rate of 2% should be raised. Both the Wall Street Journal and economists at think tanks have made similar calls in the past few months.

The push for higher inflation rates is just the latest sign that rich bankers and other members of the ruling class aren't hurt by rising prices as much as regular people are. High price inflation is often good for billionaires and technocrats, either financially or politically. If the Fed tries to keep any tightening of the money supply going into next year, we can expect Wall Street and Washington insiders to put more pressure on them.

Wall Street Wants More "Flexibility" for the Central Bank 

Harris's comments for Bank of America show how comfortable Wall Street is with high price inflation. Harris started off by saying, "2% is nothing special, except that it is the official goal in many countries." Harris is right, but he has bad reasons for doing what he is doing. Harris just says that the 2% standard is made up out of thin air to argue for a more active Federal Reserve. Harris says that "The fact that steady 4% inflation costs less than steady 2% inflation shows that it is true. No matter what happens, the economy adjusts. Maybe the goal for inflation should be 3 or 4%."

The part about how the market changes is particularly random. For banker economists who aren't in touch with real people and the real economy, it seems like the "economy" is an abstract thing that "adapts" and there's no need to worry about it.

But the "economy" is not just an idea; it is made up of real people. People have a harder time "adapting" when their wages are negative in real terms, which has been the case for months, or when inflationary monetary policy causes a boom-and-bust cycle that leads to unemployment. Pensioners from the middle class whose fixed incomes don't keep up with inflation also find it hard to "adapt."

On the other hand, investment bankers and billionaires with hedge funds can "adapt" because they can simply take on more and more risk as they look for yields above the rate of inflation. Sure, if things go wrong, they might have to sell a vacation home or take a hit on their stock options, but they won't have to feed their kids with generic mac and cheese.

Harris isn't alone in pleading for more price inflation. Earlier this month, Wall Street Journal writer Jon Sindreu was already on the same bandwagon when he asked “Why must inflation be around 2%?” He went on to claim that what really matters is not low inflation but stable inflation. Thus, the real problems with inflation "stem from inflation accelerating, not its being high." Thus, he asks

what if inflation stabilizes at a higher rate—say between 4% and 6%? In this plausible case, central banks may be compelled to start needlessly raising rates again. ... Inflation of 4% is perfectly compatible with a healthy economy that isn’t overheating. 

This came only a few weeks after the Roosevelt Institute—where New Keynesian economist Joseph Stiglitz is head economist—called for a higher inflation target. Specifically, the Institute wants an inflation "range" from 2 to 3.5 percent using the PCE deflator. This would lead in practical terms to real shift upward in target inflation. After all, according to the PCE measure, price inflation barely exceeded the 3.5 target even at the height of the housing bubble in 2008. In other words, even in a red-hot bubble economy, price inflation could still come in within the preferred range, meaning monetary tightening would almost never be seen as necessary or urgent. 

Clearly, the trial balloons for higher target inflation are already being floated, and once CPI inflation returns to anywhere near 4 percent, we should expect to hear howls from Wall Street and Washington about the "need" for the Fed to once again drive down interest rates while propping up asset prices. 

How Target Inflation Keeps Moving Up 

We've been down this road before. 26 years ago, the debate was over whether or not the target inflation rate should be raised to 2 percent. Before that, Congress had put into legislation a target of zero percent. 

In the "Full Employment and Balanced Growth Act of 1978" Congress explicitly added a "stable prices" mandate to the Federal Reserve Act, and stated that CPI inflation should be reduced to 3 percent or less. Moreover, by 1988, the Act imagined that the official inflation rate should be reduced to zero:

Upon achievement of the 3 per centum goal ... each succeeding Economic Report shall have the goal of achieving by 1988 a rate of inflation of zero per centum." 

Some monetarists and "hard money" advocates, who were against the Keynesian consensus that led to the runaway inflation of the 1970s, pushed for inflation of 0%. The victory of these "hawks" was short-lived, though. By the end of the 1980s, Alan Greenspan and other economists like Janet Yellen, who were more "dovish," had taken the lead. Even Volcker had moved back toward easy money, which is clear from the fact that he backed the Plaza Accord.

Economist Brendan Brown writes in his book The Case Against 2% Inflation:

The Volcker Fed's abandonment of "hard money" policies and the monetarist experiment led directly to the global monetary inflation of the late 1980s featuring virulent asset inflation, most spectacularly the bubble and bust in Japan. Germany was the last to abandon monetarism formally with the launch of the euro. 

Within a few years there was the start of anew stabilization experiment-the targeting of perpetual inflation at 2% p.a. A key milestone was the FOMC meeting of July 1996 which considered the issue of whether with inflation now down to below 3% the Fed should go easy on its drive to ever-lower inflation and accept a continuing stable low inflation around 2%. Janet Yellen presented the paper in favour. There followed no firm resolution. Nevertheless then Chief Greenspan agreed to a pause. A stronger commitment to a target of perpetual "low inflation" emerged in subsequent years, both under the late Greenspan years and more especially under Chief Bernanke.

The Fed followed the European Central Bank's formal adoption of a 2-percent standard at first informally, and then officially in 2012. Even that didn't last long. In August 2020, the Fed said that it would start aiming for "average" inflation of 2%. This meant that the Fed would sometimes aim for inflation above 2%, but the long-term goal was still 2%. Now, in 2022, we're talking about raising the target inflation rate again, maybe to "between 4% and 6%," as The Wall Street Journal suggests. Not mentioned is the fact that the Fed was able to ignore inflation as it kept going up in 2021 because inflation targets kept going up. At that time, the Fed wanted inflation to be well above 2% in order to reach this new "average" of 2%. Because of this, the Fed became lazy and let inflation reach its highest level in 40 years.

Easy money will always be appealing, especially to those who can get the most out of it. This last group includes a growing number of "zombie" corporations, governments with a lot of debt, and a "financialized" Wall Street, where valuations don't take into account fundamentals but instead depend on being able to borrow money at low rates and profit from rising stock prices. The "easy money" chorus couldn't care less about small business owners who can't make a living because prices are too high or about old people on fixed incomes. All that matters is getting back to easy money, even if that means making inflation goals higher and higher.