In his Monday’s article on Wall Street Journal, Martin Feldsetin writes about how the Fed isn’t showing its strategy if sudden inflation surge comes when the economy gets fully out of the recovery. Feldstein, a professor of economics at Harvard and a former chairman of Council of Economics Advisors under Raegan, is known for being inflation hawk all the way back to 2009. According to him, Fed policymakers should inform about what they can do with their monetary tools if there ever will be an inflation hike in the process of the recovery in their guidance statement. He then explains possible monetary tools the Fed can utilize to fight against inflation. His recommendation includes increasing fed funds rate, increasing interest rate on reserves, using reverse repurchase program and increasing required reserve in the banks. He believes all of this policies may not be sufficient or politically possible task to do for the Fed.
Then Paul Krugman mocks Feldstein’s being pre-hawkish on his Tuesday blog post. Krugmans sums up Feldstein’s article in the post:
The point is that this has to be one of the weakest policy arguments I’ve ever seen: Arguing that the Fed should shy away from doing all it can to create jobs because you’re afraid that at some point in the future Fed officials will be insufficiently hawkish because they’re afraid that people will make fun of them.
To me, Krugman clearly doesn’t see the main point of Feldstein’s article. Feldstein says simply that the Fed should be saying what it will be doing if inflation comes from let’s say nowhere. But Krugman interprets it as Feldstein was being hawkish and recommending the Fed to stop expansionary monetary policy as soon as possible.
Feldstein’s recommendation that the Fed should be guiding the market on what it will and can do under the pressure of inflationary period is interesting and actually might be good add-on to their forward guidance for the Fed policymakers because: by simply reminding the market that there still could be some possibility of inflation hike (however small this possibility is) and showing off their guns and ammo for inflation hike, the Fed could raise public’s inflation expectation.
If the Fed does what Feldstein suggest and includes possibility of higher inflation, the market’s inflation expectation can be shifted because of the Fed’s being pre-hawkish. Increasing market inflation expectation is exactly what the Fed has to do right now when PCE inflation index has been under the Fed’s inflation target of 2 percent for 21 straight months. Moreover, the current doubt that the Fed might be targeting 2 percent inflation as an upper limit for the target, not target, could be cleared if the Fed leaves some room for inflation raise possibility on its statement.