The Fed May Not Recognize Inflation Until It's Too Late

The Federal Reserve has come around to the conclusion that inflation isn’t going to be a problem. So now it’s time to start wondering if inflation is going to be a problem. The Fed has a tendency to fight the last battle, which could lead policy makers to miss what may be the “Great Inflation” era.

The U.S. economy was unlikely to suffer an inflationary outbreak after the last recession simply because the Fed still retained too much fear of a 1970s repeat. In practice, its 2% inflation target made it appear that 2% inflation was a ceiling and overshooting that ceiling was never acceptable. The central bank based its policy on inflation forecasts rather than actual inflation even though those forecasts relied heavily on empirical estimates of the Phillips curve that posited a stronger relationship between unemployment and inflation than was revealed in the real world.