Richmond Fed, Report: Trade-offs in Fulfilling the Fed’s Dual Mandate

“There are several good reasons why low and stable inflation is desirable. High inflation tends to distort prices and incentives to hold cash and buy certain goods and services. Furthermore, unstable inflation generates uncertainty in income and wealth holdings.”

“On the other hand, policymakers are justified in accepting some inflation instability if this avoids such an excessive volatility in unemployment over the business cycle.”

“One complicating aspect is that the costs and benefits may be very different across households. Households that normally face high unemployment and hold little in nominal balances may be willing to accept inflation in a way that households with stable employment and large nominal positions may not. Similarly, households that more heavily focus their expenditures on goods that respond significantly to inflation (such as gas or food) may be more concerned about inflationary fluctuations.”

“The post-pandemic surge in inflation has generated renewed worries about unanchoring of expectations. As the discussion above makes clear, such concerns are justified, as unanchoring severely limits the Fed’s ability to attain its objectives of stable prices and maximum employment. Such limits would be particularly harmful to households with high unemployment rates and a large fraction of their baskets dedicated to inflation-sensitive goods.”