How to prepare for disinflation

Ball, Leigh, and Mishra’s analysis, fortunately, provide clues to what Chair Powell and other policymakers can do to make the prospect of disinflation less scary. Firstly, the key role played by expected inflation in the paper’s Phillips curve implies that, to the extent that the Fed can bring expected inflation back down, actual inflation will follow without hardly any cost in higher unemployment. The best way for the Fed to do this would be to adopt and announce a specific monetary policy rule – or at least spell out a coherent multi-year plan – that would describe more fully to the public how the Fed plans to adjust its federal funds rate target to stabilize inflation under various scenarios, benign and more toxic.

Secondly, since labor market tightness, not the unemployment rate alone, governs inflationary dynamics, leaders in Congress and the Biden administration should look for ways to help lower inflation by reducing the natural rate of unemployment. Fiscal and regulatory policies that currently discourage firms from creating jobs, and potential workers from looking for jobs, should be replaced by policies that favor job creation and search instead. Finally, as Ball, Leigh, and Mishra suggest supply constraints have persistent effects on measured inflation, policymakers should take every opportunity to ease those constraints. They might focus first, for example, on reversing recent policy actions that have stymied domestic oil and gas exploration and production.

Economists are correct in warning the public about the likely costs of disinflation. But leaders within and outside the Fed should not sit back and take these costs as given. The costs are “endogenous,” as economists also like to say. Policymakers can coordinate to make disinflation much less scary.