A radical idea for solving the inflation problem proposed by a radical former Fed

New York
CNN
—

Millions of Americans are frustrated that their dollars don’t go as far as they once did at the supermarket, rent or car insurance.

Judy Shelton,A controversial economist who was put forward by former President Donald Trump as a potential candidate to head the Federal Reserve if he wins the November presidential election, proposed a radical solution: the Fed should strive to zero inflation altogether.

Currently, the Fed aims to maintain a stable inflation rate, with prices rising at a slow but steady rate of just 2%. This should happen so gradually that people barely notice it.

A zero percent inflation target might be popular, but it would represent a sharp departure – one that mainstream economists warn would backfire.

“Stable inflation is an oxymoron because it means it’s not stable,” Shelton told CNN in a recent interview.

Shelton, whose Trump unsuccessfully nominated to the Federal Reserve Board in 2020 has long argued that a zero-inflation target would help ordinary Americans who suffer when their wages fail to keep up with prices.

“Why not just go ahead and set it to zero, which will make life much easier for all of us who have to use the dollar and constantly express things in inflation-adjusted terms?” said Shelton, who is the author of a new book about money called “Good as Gold.”

But mainstream economists and Fed watchers warn that the Fed’s zero-inflation target would be dangerous.

“I think it’s a bad idea. That’s the wrong approach,” Mark Zandi, chief economist at Moody’s Analytics, told CNN.

The biggest fear expressed by Zandi and others is that zero inflation is uncomfortably close to deflation, an environment of falling prices that terrifies economists and central bankers alike.

“Deflation was the hallmark of the Great Depression,” Zandi said, noting that falling prices made it almost impossible for businesses and consumers to repay their debts. “If history is any guide, you don’t want to go down that path. It never worked out well.”

While deflation may seem surprising to consumers (who doesn’t like discounts?), in practice, falling prices cause people to delay purchases.

After all, why spend $300 on a grill today if you think it will be cheaper in a few weeks? These delays could cause prices to drop further, causing even more delays. Rinse and repeat.

“Deflation could become an endless spiral because monetary policy is unable to counter it,” said Justin Wolfers, an economist at the University of Michigan who supported Vice President Kamala Harris.

In fact, one of the reasons the Fed has set its inflation target at 2% is that the Fed is a safe distance from the deflation danger zone.

Another reason: Research suggests that official inflation measures are flawed – they may overestimate real inflation. And that means reaching the zero target could translate into deflation.

“It’s a bit like walking along the edge of a cliff. A zero inflation target would mean a path on the edge. The 2% target is a few steps away from the brink. It’s safe because if something goes wrong, you won’t fall off the cliff,” Wolfers said.

Bill English, a Yale University professor and former top Fed official, said deflation may be difficult to escape because eventually the Fed will no longer have room to cut interest rates.

The Fed never lowered interest rates below zero, even during the Great Recession.

“Policymakers want a buffer from the zero lower bound. Two percent is a reasonable number,” English said.

Shelton dismissed fears of deflation and its impact on the consumer psyche.

“You can have a healthy economy with a little deflation and I don’t think that will impact people’s decisions,” Shelton said. “I think we need to trust supply and demand and let people respond to price signals and not feel like we’re controlling their behavior.”

This is not the first controversial position of Shelton, who has both called for a return to the gold standard and attacked the Fed’s independence in the past.

But even some of Shelton’s biggest fans oppose her adoption of a zero-inflation goal.

Stephen Moore, a senior fellow at the conservative Heritage Foundation, told CNN in a telephone interview that he had privately urged Trump to consider appointing Shelton to replace Fed Chairman Jerome Powell when his term expires in 2026.

Moore, who said he doubted Trump would fire Powell instead, he may just “wait it out,” adding that his wish list for Fed chairman includes former Trump White House economist Kevin Hassett and former Reagan economist Arthur Laffer. He said Trump was open to all three names.

But even Moore said he disagreed with Shelton’s zero-inflation goal.

“My worry is that if you hit zero and the result is negative, it will be deflation. And deflation is really bad,” Moore said. “I would rather side with too much inflation.”

Shelton was then nominated by Trump to the Fed board in 2020 Moore withdrew from the competition.

Moore’s candidacy collapsed following CNN’s KFile reporting on the story disparaging comments he did about women. (He told CNN at the time these remarks surfaced “parody”.)

Moore told CNN he is not interested in any job requiring Senate confirmation, although he would be open to other roles such as helping oversee the project government efficiency commission appointed by Elon Musk.

“The Senate confirmation process is brutal. I’m not going through this anymore,” Moore said.

For her part, Shelton dismissed speculation that she might be nominated to lead the Fed.

“I haven’t really thought about it … I haven’t pitched myself as a candidate at all,” Shelton told CNN, adding that she would recommend someone like Laffer or James Grant, founder of the investment publication Grant’s Interest Rate Observer.

Shelton argued that more than who would continue to run the Fed, what was most important was the central bank adopting a new stance focused on maintaining Americans’ purchasing power.

“Where is the responsibility? “No one has been laid off in recent years due to high inflation,” Shelton said.