27 May 2019
If Janet Yellen runs a high-pressure economy, the Fed would have to further dial back the pace of hiking interest rates. Photo: Bloomberg
If Janet Yellen runs a high-pressure economy, the Fed would have to further dial back the pace of hiking interest rates. Photo: Bloomberg

Why Yellen’s ‘high-pressure economy’ approach is a bad idea

US Federal Reserve chair Janet Yellen on Friday mentioned the concept of a “high-pressure economy” and hinted at the possibility of allowing inflation to run above the 2 percent target rate in order to foster a stronger recovery.

Yellen made the speech at a Boston Fed conference on The Elusive “Great” Recovery: Causes and Implications for Future Business Cycle Dynamics.

The term “high-pressure economy” was coined by Arthur Melvin Okun, father of the Misery Index and former chairman of the Council of Economic Advisers.

He suggested policymakers should abandon inflation targets if economic growth lacks momentum and people’s livelihood is miserable.

In such situations, we should accept a lesser evil and tolerate higher inflation temporarily while the economy tries to regain momentum and get back on the growth track, Okun said.

However, Okun did not bother to dwell on the pros and cons of high inflation.

In fact, soon after he came up with his theory on high-pressure economy, the United States went through an extended period of high inflation in the 1970s and 1980s.

Then Fed chairman Paul Volcker worked very hard before inflation was tamed, and the experience serves as a warning to central bankers about the serious effects of inflation.

As a result, Okun’s high-pressure economy has never become popular.

By bringing up Okun’s theory, is Yellen hinting at an easier stance on interest rates?

It looks like US policymakers have run out of ammunition to revive economic growth and have to go back to more easing.

If the Fed runs a high-pressure economy, it would have to further dial back the pace of hiking interest rates.

That means the extra-low rate environment would stay longer than expected.

Nevertheless, after rounds of quantitative easing over the past eight years by major economies, the United States, Europe and Japan are still facing lackluster growth.

Perhaps policymakers in major economies should just accept the fact that we’re in the middle of economic stagnation, go through the painful process of eliminating excess capacity and patiently wait for a new growth engine to emerge.

Unfortunately, the right way may not be politically acceptable.

That is why governments around the world continue to adopt short-sighted policies for instant benefits.

This idea of high-pressure economy is one of those.

This article appeared in the Hong Kong Economic Journal on Oct. 18.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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