Could America soon have an inflation problem?

• Position: A SYMPOSIUM OF VIEWS

Economist Marty Feldstein argues that because short-term unemployment is so low, the result could be that "inflation could soon begin to rise year after year without any further decline in overall unemployment." Others argue that inflation will accelerate for a different reason: because of the increased size of the monetary base. Other economists, including Brad DeLong, argue that the inflation worry is vastly overblown.

Is the United States flirting with an inflation problem? Moreover, what are the risks of policy error on the inflation issue? In the 1990s, for example, after a period of low interest rates, the Federal Reserve raised short-term rates with significant unintended consequences, including the outbreak of the Asian crisis and the Russian default. Today the risk would be the unwinding of the global carry trade and dangerous loss of liquidity throughout emerging markets.

Are Fed policymakers today behind the curve on the inflation front? Or is all this talk of monetary tightening playing with fire?

ALICE RIVLIN

Senior Fellow in Economic Studies, Brookings Institution, and former Vice Chair, Federal Reserve Board

It would be really nice to have to worry about inflation again. If the economic outlook were for robust growth, tight labor markets, rising wages, even a few shortages of skilled workers, economic policymakers would feel more cheerful. The Federal Reserve could then confidently raise interest rates to what used to be considered "normal" levels.

Alas, that is not the situation policymakers are facing in 2015. The optimistic view is that the U.S. economy has enough positive momentum to keep the recovery going, push unemployment down a tad more, encourage stronger labor force participation, and nudge inflation back up to the Fed's 2 percent target. The pessimistic view is that weakness in the rest of the world and the strong dollar will cut our exports and make the momentum hard to maintain.

The longer-run outlook is not encouraging, either. Labor force growth will be slow, estimates of potential growth are being revised downward, and our gridlocked politics precludes the bold public investments that could help the economy grow more strongly. The situation in Europe, the United Kingdom, and Japan is hardly more cheerful. Inflation is not on the horizon in any major developed country. Indeed, potential deflation is higher on the list of potential threats.

Moreover, even if some unforeseen set of shocks were to accelerate price increases, there would be little risk of inflation getting quickly out of hand. The U.S. economy is much less inflation-prone than it was in the 1970s and 1980s, when central bankers felt they had to keep a wary eye on the inflationary beast lest it leap out of its cage and get away from them. Our economy is far more competitive than it was in those days, supply chains are more responsive, unions are a disappearing force for wage increases, multi-year wage contracts with escalator clauses are a thing of the past, and outsourcing has become the norm. Most importantly, inflationary expectations have gone dormant and are unlikely to revive quickly. The robust growth and tight labor markets of the late

1990s did not produce worrisome inflation. The following decade's run-up to the financial crisis produced a housing price bubble without general inflation. A whole generation has grown up reading about some vague thing called inflation without experiencing it. They are not likely to take the self-protective actions that used turn a little inflation into a serious threat.

So let's cross inflation off our list of worries and get back to the real world of the twenty-first century. We need to figure out how to grow the economy faster and share the prosperity more widely. If we are really successful, we might earn the luxury of worrying about inflation once again.

MARTIN FELDSTEIN

George F. Baker Professor of Economics, Harvard University, President Emeritus, National Bureau of Economic Research, and former Chairman, Council of Economic Advisors

The American economy is at or near the inflation threshold level of employment: the overall unemployment rate is 5.5 percent, the unemployment rate among college graduates is just 2.5 percent, and the unemployment rate among those who have been out of work for less than six months is less than 4 percent. Based on past experience, these unemployment rates imply that the core inflation rate will soon be rising past the 2 percent level that the Fed has set as its target.

The Federal Open Market Committee has nevertheless signaled that it will keep the real federal funds rate below zero for the rest of 2015 and will approach a zero real level of the federal funds rate only at the end of 2016. Those low federal funds rates and the Fed's continued large balance sheet imply an easy money condition that will cause unemployment rates to decline further and the rate of inflation to rise more rapidly. This rise in the inflation rate will be reinforced by the current reversal of the oil price decline and by the end of the very rapid rise of the dollar against the euro and Japanese yen.

Short-term interest rates are therefore too low and are rising too slowly. Getting interest rates back to an appropriate "normal" level might require a more rapid increase in the federal funds rate than the Fed is projecting. That could trigger destabilizing shifts in the behavior of investors and lenders who have been driven by the Fed's low interest rate policy to reach for yield with high-risk strategies.

Investors have bid up the prices of equities and long-term bonds. Their search for yield has also led to narrower spreads between Treasuries and lower grade bonds and emerging market debt. The rapid rise in market interest rates that the Fed might have to bring about in order to limit the increase in inflation would cause a flight from these higher-risk assets with a resulting sharp increase in their yields.

Banks and other lenders have increased their lending to higher-risk borrowers and have made more covenant-light loans that provide less protection to creditors. The rise in interest rates could create problems for these borrowers and therefore for the lenders.

In short, the Fed's pursuit of an even lower unemployment rate and its willingness to accept rising inflation and negative real interest rates creates broader risks of instability for the U.S. economy. America has an inflation problem because limiting future inflation increases could destabilize financial markets and the economy.

LAWRENCE B. LINDSEY

President and Chief Executive Officer, The Lindsey Group, former Director, National Economic Council, and former Governor, Federal Reserve System

Monetary policy is inherently plagued with the twin problems of forecast uncertainty and long and variable lags between the implementation of policy and the point at which it would have an effect on economic activity. Worse, risks can emerge on either side of desired policy targets requiring either a tightening or a loosening of policy in response to incoming data. To work through this problem, the Federal Open Market Committee has traditionally endeavored not to position itself too far off "center court," following a monetary policy that neither runs too much in the restrictive direction or too far in the accommodative direction, and thus can be adjusted quickly as times change.

This is not the case today. The FOMC has a near-zero short-term interest rate in place coupled with a massive position of almost $4 trillion in longer-dated securities. This portfolio was accumulated with the express purpose of pushing the effective stance of monetary policy below the "zero bound," in effect running a policy with a negative interest rate. One could make the case for such a policy in the dark days following the financial crisis. But no one should imagine that current policy is anywhere close to "center court."

Amazingly, this emergency policy which even its supporters describe as "highly accommodative" is in place as the economy reaches an...