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Federal Reserve officials are questioning the opportunity to let inflation exceed their target by 2% more often because they are facing the likelihood that interest rates will remain significantly lower than those of the past.
The talks are preliminary but are now warming up as the Fed officially begins a re – examination of its policy framework for several months with a national tour starting this week in Texas.
The analysis of the analysis shows that the Fed's short-term benchmark rate could reach a level slightly above or slightly above the current range of 2.25% to 2.5%.
These low rates leave less room for the Fed than in the past to reduce rates during an economic downturn and increase the possibility that they will be stuck near zero longer in future recessions. In each of the last three downturns, the Fed lowered its benchmark by about 5 percentage points.
Low nominal rates leave less space for the Fed to relax in times of economic slowdown and increase the chances of rates falling back to zero in the next recession. A more flexible policy framework for higher inflation would be one way to signal the Fed's determination to take bolder steps to boost growth after a recession.
"It's a good discussion: think about the room for maneuver we have, especially if the interest rates in this cycle will not be much higher than they are already," said the president of the Commission. Fed in Boston, Eric Rosengren, earlier this month.
Fed Chairman Jerome Powell may be questioned about this review during his testimony at Capitol Hill on Tuesday and Wednesday.
Fed officials said they could use the unconventional stimulus tools they had used after the 2008 crisis, including bond purchase programs. But some, including Fed Vice President Richard Clarida, who runs the study, have expressed doubts about the effectiveness of the programs.
When central banks set their inflation targets for the first time in the 1990s, they feared that inflation would become too high and set expectations – both for business and industry. for consumers – about future inflation. Behind this approach, there was the belief that expectations play an important role in real inflation.
The Fed set an inflation target of 2% in 2012, but inflation has remained below that target for most of the recent expansion. Fed officials have defined this goal as symmetric, which means they would tolerate inflation slightly higher or lower than this. A measure of inflation excluding food and volatile energy categories has averaged 1.6% since the adoption of the goal in 2012, although ############################################################################### 39, it recently stood at 1.9%.
The risk that Americans expect inflation below 2% "calls for a reassessment of the dominant framework of targeting inflation," said Friday the president of the Fed in New York, John Williams, during a conference held in New York.
The Fed is not looking to increase the 2% target as part of its review, Powell said in December. On the contrary, "we are looking for better ways to achieve the goal of inflation, for example, on a symmetrical basis," he said.
Changes in the central bank's definition of the target could strengthen the power of monetary policy during an economic downturn, Rosengren said.
"You can have exactly the same goal of inflation, but … how do you measure it [can] give you more space, "said Mr. Rosengren. For now, the Fed is not very precise about how it sets the target, he said. "Does it look back? Is it prospective? Is it over a long time? Is it on a short period? "
With the current goal, the Fed aims for inflation of 2% each year, regardless of what happened the year before – a "pass the past" approach.
Some alternatives become serious.
The first, a price level target, would require the Fed to react to what happened before. If inflation was 2% lower than a year ago, the Fed would try to catch up by allowing the next period to pass.
Former Fed Chairman, Ben Bernanke, has proposed a modified version of a price-level target that would only be used after periods in which the Fed would have lowered the rates of interest. 39, interest at zero. By moving to a price-level target during such episodes, the Fed would be essentially promising to keep rates low longer to counter deflationary expectations.
The second approach, called the average inflation target, would be a hybrid of price level objective and the current framework. It would aim for "average" inflation of 2% over the business cycle, which means that inflation should be slightly above 2% during the most favorable periods for the expected deficit to be offset.
Mr. Williams, one of the leading proponents of the second approach, gave a simple example in a speech last fall. Imagine that the central bank manages to keep inflation at 2% during periods of growth in the economy and limiting interest rates to zero. But 20% of the time, when the economy is in recession and interest rates have been reduced to zero, inflation averages 1%.
As a result, inflation in the average cycle is 1.8%, below the desired target of 2%. In turn, this lowers expectations of future inflation, making monetary policy even less effective. In this environment, "monetary policy is still swimming upstream, fighting a current of too low inflation expectations," Williams said.
"It does not seem to be changing much, but it's an important project because you're no longer following an outdated policy," said William Dudley, president of the New York Fed from 2009 to June. "If you miss less than the 2% goal, you'll try to catch up, and the Fed has not really said it yet."
An average inflation goal could be more interesting than a price level goal because it would be easier to communicate. "It offers a lot of the benefits of the price-level target framework type with a lot less complexity," said Dudley.
Others see good reasons to stick to the current approach. It worked well, said Loretta Mester, president of the Cleveland Fed, during a debate Tuesday in Newark, Delaware. "The bar must be high to make a major change," she said.
Write to Nick Timiraos at [email protected]
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