The real division is not about the acceptable level of inflation, but about its causes, and the dispute is limiting the Fed's aid to the economic recovery. The debate is between what I would describe as empiricists and theorists.
Empiricists, as the name suggests, put most weight on the evidence. Empirical analysis shows that the main determinants of inflation are past inflation and unemployment. Inflation rises when unemployment is below normal and falls when it is above normal.
Though there is much debate about what level of unemployment is now normal, virtually no one doubts that at 9 percent, unemployment is well above it. With core inflation running at less than 1 percent, empiricists are therefore relatively unconcerned about inflation in the current environment.
It seems here that Romer believes in a strong version of the Phillips Curve "“ that there is a strong structural connection between unemployment and inflation. As long as unemployment remains high, inflation cannot rise too much.
Yet simple Phillips Curve relationships have long been discredited among academic economists. The stagflation experience in the "?70s was sufficient to convince many economists that unemployment is perfectly consistent with high inflation. One influential study by Andrew Atkeson and Lee Ohanian finds that economic models based on unemployment perform no better than a coin flip in predicting inflation.
While it's true that "core" inflation has been low in the recent past, not all indicators are pointing the same way. As a recent e21 Commentary noted, the recent monthly inflation rate is currently 6.2%. A number of commodities, such as oil, have experienced large price increases "“ but are not included in the core index.
The MIT's billion price index "“ which uses internet data on hundreds of thousands of goods "“ is also running higher than the CPI, at around 2.75%. This index does exclude a number of services, like housing, which have not seen substantial price appreciation, but it also excludes some high-inflation goods, like energy.
The bottom line is that Christina Romer "“ while certainly an accomplished economist "“ is either ignoring or dismissing some very relevant information.
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