It has been some time since I have written about monetary policy.  The waves of fiscal stimulus—spending and tax cuts—have dominated the debate almost since the stock market crisis of 2008.  This week, Charles Evans, president of the Federal Reserve Bank of Chicago and leading contender to replace Ben Bernanke as the chair of the Fed, visited Indiana.  In Muncie, Dr. Evans gave an important policy speech regarding the Fed’s role in moving the economy past the recession.  This occasioned me to write about the Fed’s role and try and explain how it might change.

I begin by noting that a threat to disrupt the speech from the Muncie chapter of the Occupy Wall Street crowd slightly tarnished the day.  It increased the cost of providing security to an event and necessitated cancellation of meeting between Dr. Evans and students.  This was unfortunate.  One wag noted that all the security was unnecessary, simply posting a ‘help wanted’ sign would have been sufficient to keep the OWS folks at bay.  This is unfair, of course, but to those protestors who wish to matter, I suggest it is time to come up with workable ideas of your own instead of merely impeding others from freely sharing theirs.  

Monetary policy—the setting of interest rates and money supply—was the focus of Dr. Evans’ speech.  In it, he argued for a policy change based upon a middle ground between the two differing explanations for what is causing the lingering pain to the U.S. economy. 

At one extreme, the slow recovery is an inevitable outcome of a mismatch between the skills jobless workers possess and those employers need.  This is termed a structural problem.  If true the unemployment rate will remain very high for a very long time, regardless of policy changes.  Efforts by the Fed to stimulate employment would simply lead to inflation. An opposing explanation is that the economy is in a ‘liquidity trap,’ in which borrowing and lending are constrained by dismal expectations of the future.   It is a measure of the poverty of our political discourse that these are often labeled the conservative and liberal diagnoses of our problem.  

Dr. Evans proposed a policy that is a trade-off between the unpleasantness of continued high unemployment and higher inflation.  He argues that if we risk a tad bit higher inflation (3 percent instead of the current 2 percent target) at any time the unemployment rate is above 7 percent, we might push the economy towards what he terms ‘escape velocity’ where the private sector begins to grow. 

A year ago I would have labeled this risky.  Since then, the burst of high energy prices, which often leaves inflation in its wake, did nothing of the sort.  Inflation remains at bay, while high unemployment is sadly here. This week in Muncie, Dr. Evans amplified his proposal to accept the risk of higher inflation to potentially cure high unemployment.   It is a beguiling notion that warrants serious consideration as one of the least painful ways to escape the recession.