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It's time for the Fed to admit it doesn't have an inflation problem

Federal Reserve Chair Janet Yellen
Federal Reserve Chair Janet Yellen
Alex Wong/Getty Images

The Federal Reserve will decide next week whether to raise interest rates for the first time in almost a decade. And journalists writing about the decision (or at least the people writing their headlines) like to use the word "dilemma" to describe the situation. But a little bit of international perspective helps illustrate that the Fed isn't really facing much of a dilemma.

Take Brazil, which is currently falling into a recession. Ordinarily when an economy turns south, the central bank responds with looser money and lower interest rates. By flooding the economy with liquidity, a central bank can encourage businesses and consumers to spend more, cushioning the impact of the downturn. But there's a problem: Brazil's inflation rate is high and getting higher.

Brazillian inflation rate

Brazilian inflation rate.

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To deal with inflation, central banks need to tighten monetary policy and raise interest rates. If Brazil's central bank doesn't do this, it risks inflation spiraling out of control.

Hence, Brazil's central bank faces a genuine dilemma. Raising interest rates could push the country deeper into recession. Lowering them could bring more inflation. Both options are bad.

The Fed faces the opposite of a dilemma

Things are very different here in America. Inflation over the past year has been a minuscule 0.2 percent. That's mostly because oil prices have been falling, but even if you look at "core" inflation — which excludes volatile food and energy prices — the inflation rate is below the Fed's 2 percent target. And market projections show it's likely to stay below 2 percent for the next decade.

Meanwhile, the unemployment rate has fallen to a healthy 5.1 percent. But economic growth, job creation, and wage growth have all been a bit sluggish. So the economy is doing pretty well, but not as well as it could be doing.

So the US economy could probably use a bit more help. And with inflation low, there's little risk in the Fed providing that help. So while Brazil's central bank faces a difficult trade-off between unemployment and inflation, America's central bank has a chance to have its cake and eat it too.

Admitting you don't have a problem

So if the Fed has things so easy, why do we see so many headlines about it facing a big dilemma? One reason is that the media likes conflict and drama. "Fed faces dilemma" is a more clickable headline than "The economy is probably going to be fine no matter what the Fed does next week."

But I think a more important factor is that a lot of people haven't fully grasped how much the world has changed in the past few decades. Many of today's elite policymakers and pundits came of age in the 1970s, an era when the United States faced a problem a lot like the one Brazil faces today.

In the late 1970s, the US faced high inflation and high unemployment. That forced the Fed to decide between tough anti-inflation measures — at the likely cost of a recession — or allowing inflation to continue spiraling upward.

Under Paul Volcker, the Fed ultimately chose to focus on fighting inflation, creating a painful recession in 1980. The tough medicine worked, and a generation of economic thinkers drew the lesson that the Fed should focus on keeping inflation low. And many of them have maintained that hawkish attitude even though economic environment in the US is totally different from the one we faced in the 1970s — or Brazil faces today.