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There is nothing magical about the Fed’s putative 1%-2% comfort zone for the core PCE deflator. Nothing! There is not a single piece of economic literature, to my knowledge, that empirically demonstrates that the economy enjoys better microeconomics efficiency through “cleaner” relative real price changes at 2% than it would at 3%. None!



Thus, the Fed’s current obsession with the 1%-2% range is not a matter of economics, but of religion. Indeed, as I reported after returning from Jackson Hole last August, a very senior Fed official, known as a hawk and currently a voting FOMC member, admitted this to me, while also intoning that to lift the comfort zone would be untenable, because it would run the risk of inflationary expectations loosing their sturdy moorings.4



Governor Mishkin takes this thesis squarely on and rebuts it: if inflationary expectations are exceedingly well anchored near 2%, which he believes to be the case, they, like gravity, should help – along with monetary restraint and a mildly-opening output gap to pull current inflation that is about ½% higher than 2% down toward that level. Getting inflation down to the middle of the 1%-2% comfort zone would, however, be much more arduous, and costly – in terms of lost output and employment growth – because doing so would require shoving the inflationary expectations anchor – not just actual inflation – deeper into the disinflationary dirt.5



Without explicitly saying so, Ric openly questions whether doing so would be worth the cost, presumably because he knows there would be no microeconomic efficiency gains from doing so. I certainly buy that argument, lock, stock and barrel. And pole, line, sinker and hook.


http://www.pimco.com... April 2007.htm