Dubious Inflation Worries Why are the hawks so concerned?

• Author: Delong, J. Bradford

Back in 1992, Lawrence H. Summers, then the chief economist at the World Bank, and I warned that pushing the U.S. Federal Reserve's annual inflation target down from 4 percent to 2 percent risked causing big problems. Not only was the 4 percent target not producing any discontent, but a 2 percent target would increase the risk of the Fed's interest-rate policy hitting the zero lower bound.

Our objections went unheeded. Fed Chair Alan Greenspan reduced the inflation target to 2 percent, and we have been paying for it ever since. I have long thought that many of our economic problems would go away if we could rejigger asset markets in such a way as to make a 5 percent federal funds rate consistent with full employment in the late stage of a business cycle.

There are three ways to accomplish this. One is to raise the inflation target back to the 4 percent range that prevailed during Fed Chair Paul Volcker's tenure. Another is to boost demand so that a late-cycle federal funds rate of 5 percent would still be consistent with strong investment. And a third option is to flood the market with safe Treasury assets so that the safe-asset price premium on Treasuries falls, thereby allowing the late-cycle federal funds rate to increase. When U.S. President Joe Biden won the 2020 election and proposed his $1.9 trillion relief, rescue, support, and stimulus package, I welcomed it. With its passage, a substantial chunk of the money will go to people who could really use it, and the economy will have a better chance of returning rapidly to full employment after a year of plague and lockdowns.

To be sure, it would be better if a much larger share of the American Rescue Plan went to public investment. But unless one could be confident that ten Republican senators would be open to a public-investment push, one should not allow the perfect to become the enemy of the good. Besides, the package would lend itself to pursuing the third option--flooding the market with safe assets--so what's not to like?

Apparently, there is enough not to like that many commentators whom I respect and admire came out in opposition to the $1.9 trillion plan. I am not referring to professional Republican economists who always put partisan considerations before evidence, but to widely respected voices such as Summers and former IMF chief economist Olivier Blanchard. In a recent, widely circulated commentary for the Washington Post, Summers contends that:

... while there are enormous...