This article first appeared in Larry Summers' blog.
While I do not believe the Fed made a serious mistake Wednesday in raising rates, I believe that the "preemption of inflation based on the Phillips curve" paradigm within which it is operating is highly problematic. Much better would be a "shoot only when you see the whites of the eyes of inflation" paradigm of the kind I have advocated for the past several years.
Such a paradigm would be more credible, more likely to result in the Fed's satisfying its dual mandate, reduce risks of recession, and increase the economy's resilience when recession comes.
Many of my friends have recently issued a statement asserting that the Fed should change its inflation target. I suspect, for reasons I will write about in the next few days, that moving away from inflation targeting to something like nominal gross domestic product-level targeting would be a better idea. But I think that this issue is logically subsequent to the question of how policy should be made in the near term with the given 2 percent inflation target.
Five points frame my doubts about the current approach.
First, the Fed is not credible with the markets at this point. Its dots plots predict four rate increases over the next 18 months compared with the markets' expectation of less than two. Table 1 shows the Fed has been highly unrealistic in its forecasts for several years.