Has The Fed Drawn Precisely and Exactly the Wrong Lessons From 2008?

One might think so from reading the buzz-causing Some Implications of Uncertainty and Misperception for Monetary Policy just issued by the US Federal Reserve.

Briefly, the Fed staffers posit, “because monetary policy acts with a lag, waiting for inflation to materialize before reacting is undesirable, particularly when economic conditions are such that outsized deviations of inflation from its target are a plausible outcome.”

“Outsized deviations”!  We are but fleeting moments from that old standby, “runaway inflation.”

I rather suspect this new Fed study is but a sophisticated version of the Inflation Boogeyman, and another paean to the usual central-banker tight-money totems, and perhaps a retroactive exoneration of Fed mistakes of the past.

To be fair, the Fed staffers have reasons for their commentary, and models of macroeconomic outcomes that assume variables such as the (guessed at) natural rate of unemployment.  To their credit, the authors acknowledge the Phillips Curve is nearly prone.

But given a prone Phillips Curve, the authors warn, letting inflation out of the bag would then require horrific amounts of unemployment to re-bag the feline.  Inflation would get stuck in “high” even as factories shut down and truckers dallied with empty vans. The disconnect between inflation and unemployment cuts both ways.

If you tinker with the Econo-models enough, you get the above theoretical outcome and a justification for tight-money in nearly any situation, even before too-high inflation is on the horizon.


But in that long-ago and forgotten year of 2008 is a jaw-dropping and real-world counter-example to the New Fed Inflation Boogeyman.

Back then, the Fed worried that inflation was running too high. Yes, inflation was above 2%, with the trimmed mean PCE inflation rate reaching a peak of 2.85%   in August of 2006 (see chart below).

Did a major and sustained war have to be fought to beat inflation?

In June of 2009, the trimmed mean PCE inflation rate was 1.91% and plummeting, falling to 0.80% within another 12 months. The historical record shows the Fed quickly obtained overkill, flat Phillips Curve and all.

Inflation, far from being a dreadnought Boogeyman, had a glass jaw.

As we now know, there was a lot of carnage from the Fed decision to raise rates before the 2008 recession, which they did from a low of 1.00% in 2005 to 5.25% in June of 2007.

The lesson is that where a shovel might have worked, the Fed brought a bulldozer.


The Federal Reserve is a self-financing independent public agency, a formula that will catalyze ossification in nearly every circumstance. The macroeconomics profession has sacralized central-bank independence, and certainly recent events in Turkey lend credence to that religion. But the Fed is hardly divine.

For investors, something to ponder: Insulated, and given the theorizing, a central bank does not learn from its errors. If the Fed staff report is a window into Fed thinking, the central bank will again err in the “fight on inflation,” with potentially grave consequences for the real economy.

PS The trimmed mean PCE inflation rate, put together by the Dallas Fed, is an interesting price series that throws out high and low outlier observations. “The resulting inflation measure has been shown to outperform the more conventional ‘excluding food and energy’ measure as a gauge of core inflation,” say Dallas numbers-crunchers.

Maybe so. The chart is interesting on another score: It shows inflation never topped 9% in the Great Inflation Era, peaking at year-over-year 8.72% in June of 1980.

For a couple of generations, central bankers and many macroeconomists have intoned gravely about “runaway” and “double-digit” inflation that scourged America in the 1970s and 1980s, usually as a premise for discussions about monetary policy. Actually, GDP growth rates were higher then than now.

The Inflation Boogeyman may be easily beaten on the real-world economics battlefield, but his idol will never die.



  1. // Reply

    Thanks for pointing out this paper. I had been working on a post similar to this one to put the monetary shamanism into context just because it was on my mind. I had a similar graph as well, only using core PCE to show just how dramatic the inflationary pressures where back in the 1970’s, and to compare it to 2006-08 and today. Looking at it that way, the chicken littleism is hard to miss.

    Even so, I still get stuck in a logic knot much earlier on in the argument about whether it’s beneficial to control inflation in general. Looking at Marcus’s RGDP gap graph, in an older post I calculated that the opportunity cost of the chicken littleism that has persisted over the last 10 years is in the area of $11,200 per capita per year. If the median household income is $50,000, it would take 22.4 years with inflation running at about 10% each year to equal that cost for a household of one. So, I am more than skeptical that the inflation fixation has any merit at all.

  2. // Reply


    Thanks for your comment. Of course, many economies run with inflation a little higher than 2%, such as Australia and China.

    About the only reason I can think of to “fight inflation” is the old “accelerating inflation” argument. Otherwise, I think real economic growth is more important and worth taking some chances for.

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