Don Rissmiller is a Camp Kotok fishing pal, the new chair of the Global Interdependence Center, and a senior personality at Strategas. He is also one very thoughtful economist.

In his Weekly Economics Summary published last week, Don sets forth a serious analysis of inflation and the Fed’s 2% target. He outlines his arguments succinctly. And he ends with a series of questions about what the inflation target should be and whether there are options. Don captures the arguments that several members of the Fed’s FOMC have articulated. We expect this subject to be discussed this week. Clearly, the new Powell Federal Reserve will have to engage in this debate. We asked Don for permission to quote his piece extensively and share it with our readers, and we thank him for saying yes.

Don Rissmiller of Strategas follows:

“So, we continue to write about inflation, not because inflation is high (or likely to be high any time soon). Instead, we are moving from low levels to a little less low – and while there’s reason to believe that’s not a problem for the stock market (where nominal growth will boost revenue and earnings), there remain issues in the bond market.

“There’s also an opportunity for the Fed and other central banks to consider the recent past, and with the global economy now in pretty good shape (eg, U.S. real GDP 2.6% q/q annual rate in 4Q, and the tax cut coming), study if anything should be done differently. The topic of the inflation target is likely to continue to attract attention.

“Put bluntly, should the inflation target be precisely 2%? We have noted previously that the Fed’s goal of 2% inflation seems so familiar that it frequently goes without question that it is a ‘good’ target. But recent academic literature has continued to question whether that 2% number is correct. The 2% inflation target could be too low, and the push to achieve this ‘too-low’ target (over numerous decades) helps explain some of the unique issues in this business cycle.

“One key issue is that there is not a great reason for the inflation target to be precisely 2%. The Fed’s mandate is ‘price stability.’ If ‘price stability’ has to be translated into a number, one might pick 0%, rather than 2%. There has (for quite some time) been concern that inflation is not measured correctly, but the concern was (and is) that price indexes yield numbers that are too high rather than too low.

“Out-going Fed Chair Janet Yellen had a conversation with Alan Greenspan on this topic in the 1990s, where she argued against pushing inflation all the way to zero. Given the inability to measure inflation correctly, as well as the desire to have some cushion against deflation, 2% became the number. To make matters more complicated, this 2% number has caught on around the globe (central bankers frequently talk to each other, attend the same schools, attend the same conferences, etc).

“There has been some survey work suggesting that consumers are comfortable around a 2% inflation rate. But these surveys generally cover consumers’ experience with an inflationary past (eg, the 1970s). When inflation is already low, or deflation present, it is not clear that these results are robust. Even if ‘around 2%’ is the right answer, ‘exactly 2%’ or ‘2% as a ceiling’ could have unintended consequences.

“So, how could 2% be too low? Put simply, there still appear to be too many central banks that are stuck at the ‘zero-bound’ (or slightly below, based on recent experiments with negative interest rates). That’s a key piece of evidence that something is amiss. With a 2% inflation target, if policy rates are cut to zero, there’s a -2% real rate to help kick the economy out of its doldrums. If the inflation target were instead 4%, a zero nominal rate would equate to a -4% real rate (ie, a bigger kick). The fact that many central banks are still at (or close to) the zero bound suggests that the ‘kick’ given to the economy this cycle was simply not big enough initially. There are certainly costs and benefits, but it’s worth noting that the historical average of U.S. CPI inflation is 3.5% (ie, the economy has functioned adequately at creating wealth, etc. with inflation above 3%).

“There are alternatives like price level targeting or nominal GDP targeting which could also guide monetary policy. The idea that something needs to change seems to be gaining traction, regardless. Fiscal policy, of course, is an alternate solution but the recently passed U.S. tax bill means some of this stimulus is coming early.

“Given the maturing U.S. business cycle, rates may not stay in positive territory long – that is the consequence of starting out with a limited ability to pull the real economy back up (ie, an inflation target that’s too low). This final point helps explain why the Fed has been so focused on financial developments – the FOMC wants to know when the market is doing the tightening for them. For now, financial conditions remain easy, but this is likely to remain on the Fed’s radar for some time to come.”  Many thanks again to Don.

As for President Trump, SOTU, market volatility, and deploying the cash reserve, we will hold those words for another discussion.