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- The Fed should ask itself if it's already won its war against inflation, Paul Krugman says.
- The Nobel laureate said the central bank's narrow inflation measures lag economic reality.
- Its inflation gauge is like "a one-eyed bearded man with a limp," Krugman added.
The Federal Reserve may have already won its fight against historic inflation, and remains overly fixated on flawed price measures, according to Paul Krugman.
The Nobel Prize-winning economist and New York Times columnist said Wednesday that the central bank shouldn't raise interest rates any higher – and that it's overestimating the inflation threat by relying on narrow, lagging measures that don't reflect the current economic reality.
"The Fed is using narrower and narrower measures – kind of a one-eyed bearded man with a limp measure of inflation to suggest that we are not actually seeing improvement," Krugman told Yahoo Finance. "But most measures do say that things are better."
"Right now the Fed should say, 'Gee, are we sure that we haven't already won this war?'" he added.
Wednesday's Consumer Price Index report showed that inflation cooled by a percentage point in March, falling to 5%.
But the Fed uses the Personal Consumption Expenditures index as its chosen inflation gauge – and that's been cooling at a slower rate, with its reading for March not due for another two weeks.
Krugman also cautioned Wednesday that by focusing too much on PCE, the Fed risked missing out on an "immaculate disinflation" scenario – when inflation falls significantly without unemployment rising.
Last week's payrolls report showed that the US added 236,000 jobs in March, while the unemployment rate only fell slightly from 3.6% to 3.5% despite the Fed's aggressive rate hikes over the past year.
"So many definitions of underlying inflation that you can almost always find a number that confirms your priors. But this report still looks like 'immaculate' disinflation — inflation falling without any rise in unemployment," Krugman said in a tweet Wednesday that also included a graph tracking the six-month percentage change of inflation over the last four years.
—Paul Krugman (@paulkrugman) April 12, 2023
The Fed will ruin its chances of achieving this outcome if it lifts interest rates too high, Krugman told Yahoo Finance.
"There's two questions: One is whether it's possible ... the other is whether they can pull it off," he said.
"The Fed is kind of predicting a recession," Krugman added, referring to Fed minutes released Wednesday that showed the central bank's own economists forecasting a mild recession in 2023. "It's quite possible that they will end up having generated a recession that we didn't need."