These steps haven’t entirely disappointed. Interest rates on government debt dropped as a result, but perhaps more important so did rates on mortgage-backed securities and corporate bonds. The Fed’s initial asset purchase plan (QE1), begun in late 2008 and scaled up to $1.7 billion in size in early 2009, coincided with a turnaround in stock prices. Expectations of future inflation, which fell toward zero in early 2009, turned around and began rising, signaling an ebbing threat of falling prices. By June of 2009, the economy was growing again. Subsequent purchase plans announced in August of 2010 and September of 2011 buoyed up an economy dipping toward recession and deflation amid headwinds from Europe and a congressional showdown over the debt ceiling.
While keeping deflation at bay might prevent a repeat of the 1930s, it can’t deliver a fast recovery. Indeed, some critics have argued that the recovery has been hamstrung by the Fed’s seeming unwillingness to tolerate inflation above its 2 percent target. That inflexibility has prevented the economy from growing at a temporary above-trend rate, which is necessary to make up ground lost during the recession. Market moves tell the tale. As the recovery has progressed, a rock bottom rate of construction has led to a slow tightening in housing and office markets, which has finally begun to raise rents and asking prices. That’s a positive sign for builders and should also encourage banks worried about the safety of credit extended to new projects.
But higher rents feed into measures of inflation. And when annual rates of inflation have moved toward the Fed’s 2 percent target, futures markets have adjusted in ways that hint at doubts about the Fed’s commitment to recovery. In January, the Fed hinted that it would allow interest rates to stay low until late 2014, and the economy began to gain pace. As growth geared up, however, markets began to question the Fed’s guidance, thinking that Bernanke and company would eventually balk at rising inflation and end the party early. By March, markets were trading in ways that suggested a belief that rates would actually begin rising in 2013, dashing hopes for a strong recovery. The Fed’s 2 percent inflation obsession seemed to have become a speed limit on recovery.
And so Charles Evans, president of the Federal Reserve Bank of Chicago, began arguing that America may need to tolerate a short period of higher-than normal inflation. He recommends that the Fed promise to continue boosting the economy until unemployment falls to 7 percent (it’s now at 8.1 percent) so long as inflation remains below 3 percent. Strikingly, the Fed seems to be doing just that.