As the Federal Reserve still holds onto its hawkish bias amid the still-elevated inflation, economists, including Paul Krugman, have been sounding out the need for increasing the central bank's inflation target.

Inflation, though retreating from the levels in the summer of 2022, is still above the Fed’s target of 2%.

What Happened: Krugman backed Harvard University professor Jason Furman's call for a 3% inflation target and said the rationale for a 2% target has been overtaken by a couple of decades' experience.

The Nobel laureate shared his opinion in a post on X by quote-tweeting Furman's Wall Street Journal op-ed regarding the same.

In the op-ed, Furman argued that doing away with the 2% inflation target formally introduced in 2012 and shifting to a higher target will cushion the economy against severe recessions.

“When the economy slows, higher inflation means that price hikes and wage freezes can become a less unpalatable alternative to widespread layoffs for businesses looking to cut costs,” he said.

A higher inflation rate also boosts investment as nominal borrowing costs become less burdensome when businesses can meet them with future price increases.

Furman, however, did not rule out negative impacts such as the “time and attention people spend trying to account for how much their current dollars will be worth in a year or 10.”

For a successful transition, the Fed has to clarify that the upward adjustment of the inflation target is not merely to avoid the pain of lowering inflation, the economist said. Secondly, the Fed needs to stick with the target, he added.

See Also: Best Inflation Stocks

Opinion Diverges: Krugman said he, however, does not agree with Furman's suggestion that there is more work to do and the hardest part may still be ahead.

Krugman noted that most measures of underlying inflation are around 3% now.

I'm puzzled by his assertion that there's a lot of work still to do, and that the hardest part may still lie ahead. Most measures of underlying inflation are currently sitting around … 3%. E.g.: 2/ pic.twitter.com/vy67JGIH5P
— Paul Krugman (@paulkrugman) August 21, 2023

“So if you think 3% is the right target, shouldn’t we be declaring victory?” the Nobel laureate said.

“Or to put it a different way, if 2% was a mistake, how many people should lose their jobs for a mistake,” he added.

Raising the inflation target gives the Fed the leeway to pivot and start lowering rates. Higher interest rates have often been cited by companies for slowing demand for their products and services.

Electric vehicle maker Tesla‘s CEO said in July on the company’s earnings call that higher interest rates may force the company to lower the prices of its EVs. This in turn is expected to eat into margins and impact profitability.

The ProShares Inflation Expectations ETF (NYSE:RINF), an exchange-traded fund that tracks the performance of the Citi 30-Year TIPS Index, ended Monday’s session up 1.04% at $33.71, according to Benzinga Pro data.

Photo by TANYA LARA on Shutterstock

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Tuesday, August 22, 2023

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