Running the economy hot

Feb 23, 2018

WHEN should policymakers stop stimulating an economy? America’s unemployment rate is 4.1%. At such a low level, the Federal Reserve, the central bank, would normally expect inflation to rise. In 2017 the economy grew by 2.5%, spurred by falls in joblessness that cannot go on forever. And inflation—though still below the Fed’s target—has overshot forecasts in recent months. All that might suggest that stimulus has become unnecessary. Yet America is cutting taxes and raising spending. As a result, in 2018 and 2019 it is poised to run an experiment. By stimulating economic activity when times are already good, it will find out what happens when the economy runs hot.

The target at which central bankers usually aim when setting monetary policy is the so-called “natural” rate of unemployment. It is elusive. After the financial crisis, when unemployment rose to 10% but inflation failed to subside, some economists speculated that the natural rate was as high as 6.5%. In hindsight those forecasts were far too pessimistic. Today, after years of...Continue reading

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