The key question is whether the Fed is more concerned with fighting inflation or lowering the chance of a recession
With inflation reports coming in so high, it’s getting harder to defend my membership on “Team Transitory”. Yet I remain committed to the view that higher inflation is, in fact, transitory. After a few years of above-average inflation, prices will return to a steady state of about 2% annual growth, as has mostly been the case since the early 1990s.
But central banks have many policy instruments at their disposal, including the management of expectations, and it is usually a mistake to bet against them. And the implication of a liquidity trap is that the Fed cannot increase the rate of inflation in deflationary times, not that the Fed cannot reduce it in inflationary times.
One way to view the Fed is as an independent institution with a mandate to maintain stable prices. Chair Jerome Powell has made this goal more flexible by instituting “average inflation targeting”, and this policy does give the Fed some leeway in deciding when the rate of inflation should fall. But it doesn’t grant the Fed licence to allow 5% annual inflation for the next five or 10 years. If the Fed broke with its mandate, it would lose much of its credibility.
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