Tags: Krugman | Fed | rates | inflation

Krugman: Fed Should Remain Cautious About Raising Rates

By    |   Wednesday, 11 March 2015 07:00 AM

Many economists expect the Federal Reserve to begin raising interest rates around mid-year, but Nobel laureate economist Paul Krugman isn't so sure that's a sound strategy.

Is the economy strong enough to warrant a rate hike? "I don't know, but neither does the Fed," he writes in The New York Times.

"The question, then, is what to do in the face of that uncertainty, with no inflation problem yet in sight." The Fed's favored measure of inflation registered only 0.2 percent in the 12 months through January.

"To me, as to a number of economists — perhaps most notably Lawrence Summers, the former Treasury secretary — the answer seems painfully obvious: don't yank away that punch bowl, don't pull that rate-hike trigger, until you see the whites of inflation's eyes."

For the Fed to achieve its dual mandate of price stability and full employment, that means achieving the nonaccelerating inflation rate of unemployment (Nairu), which is consistent with that inflation target.

"The Fed currently estimates the Nairu at between 5.2 percent and 5.5 percent, and the latest report puts the actual unemployment rate at 5.5 percent. So we’re there — time to raise interest rates!" he proclaimed.

"Or maybe not. The Nairu is supposed to be the unemployment rate at which the economy overheats and an inflationary spiral starts to kick in. But there is no sign of inflationary pressure. In particular, if the job market really were tight, wages would be rising quickly, whereas they are in fact going nowhere."

The Fed has an inflation target of 2 percent. "If it turns out that the Fed has waited a bit too long, inflation might overshoot 2 percent for a while, but that wouldn't be a great tragedy," Krugman says. "But if the Fed moves too soon, we might end up losing millions of jobs we could have had."

The central bank has kept its federal funds rate target at a record low of zero to 0.25 percent since December 2008.

And what does Summers have to say? "[The Fed] should not raise rates until there is clear evidence that inflation, and inflation expectations, are in danger of exceeding its 2 percent target," he writes in the Financial Times.

Summers, offers four justifications for his argument.
  • "First, real wages for most workers have been stagnant.
  • "Second, if inflation were to accelerate a bit this would be a good thing.
  • "Third, a plane that accelerates too rapidly as it takes off may cause passengers discomfort while a plane that accelerates too slowly may crash at the end of the runway.
  • "Fourth, the U.S. has never been more intertwined with the global economy."
To be sure, "inflation indicators might justify a rate increase before long," Summers says.

But "the Fed could inject much needed confidence in the economy today and minimize future risks by announcing and following a strategy of not raising rates until it sees the whites of inflation's eyes."

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Many economists expect the Federal Reserve to begin raising interest rates around mid-year, but Nobel laureate economist Paul Krugman isn't so sure that's a sound strategy.
Krugman, Fed, rates, inflation
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2015-00-11
Wednesday, 11 March 2015 07:00 AM
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