- Federal Reserve officials are actively considering a shift away from their current inflation targeting framework toward more aggressive measures to combat ultra-low inflation.
- However, the barrage of ideas being offered up adds to confusion about the outlook for monetary policy, and neglects the importance of the Fed’s employment mandate.
- New ideas range from price-level targeting, to a temporary price level target, to an inflation target range rather than the current 2% goal.
- Brookings Institution conference in Washington brought together Fed big wigs to discuss the issue.
WASHINGTON – Federal Reserve officials puzzled by chronically-low US inflation seem to agree on at least one thing: They worry, almost universally, that they will lack the tools to fight the next recession, whenever it comes.
Yet instead of focusing on tried and true policy measures like low interest rates and possibly bond buys, Fed officials current and former appear focused instead on broad shifts in the policy framework, including moving away from the current inflation targeting regime toward a potentially more aggressive approach.
More importantly, the string of discordant ideas being offered up at a Brookings Institution conference by such high profile figures as former Fed Chairman Ben Bernanke, former White House economic advisor Lawrence Summers,and two current Fed members, does more to confuse the already muddled outlook for monetary policy than clarify it.
Boston Fed President Eric Rosengren suggested the Fed follow the model of the Bank of Canada, which periodically reviews its approach to maintaining price stability. He also called for the Fed to move toward an inflation target range, which he hinted might be from 1.5% to 3%, rather than the current 2% goal.
John Williams, president of the San Francisco Fed, called for a system where the Fed would target the price level, meaning that it would compensate periods of undershooting the 2% inflation goal with periods of overshooting.
US inflation has remained stubbornly below the Fed’s 2% target for much of the economic recovery, suggesting the labor market is not as healthy as the 17-year low unemployment rate of 4.1% suggests. Shifting to a price-level target is “not nearly as scary as you might think” Williams told the audience of monetary economists, academics, and market participants.
He worried about the “issue of credibility” that has resulted from persistently below-target inflation, which makes it look “ like the central bank is not committed to its goals.” Prolonged low inflation, which also reflects soft wage growth, can make monetary policy less effective because “it gets into inflation expectations and makes it harder to achieve 2% objective in good times.”
The Fed’s five interest rate increases starting in December 2015, following a period of seven years of zero rates and $ 4.5 trillion in bond buys, reflect in part a desire to rebuild a cushion for any potential economic downturn.
Lack of tools or will?
Fed Chair Yellen indicated the Federal Open Market Committee could consider a shift under incoming chairman Jerome Powell.
“Right now the FOMC is not discussing or considering its inflation target,” she said during her December press conference. “I wouldn’t say that we’re out of ammunition, but certainly it’s been recognized—and I’ve emphasized myself that, in the longer run, we may be—and we’ll have to see how this works out, but we may be in low interest rate environments where it could prove useful to have additional scope to conduct monetary policy.
“In that context, I think additional research—the academic economists and others are thinking hard about what more could be done, and I think these are matters that are certainly worthy of further study.”
Summers argued the Fed will lack tools to fight the next recession, suggesting its bond purchases, known as quantitative easing or QE, did not work.
“I am completely unconvinced QE can be our salvation” in the next recession, he said, despite extensive evidence that the Fed’s bond buys were in fact highly effective in preventing a deeper economic downturn and sustaining the longest, if one of the weakest, economic recovery in modern history.
Starkly absent from the debate was the other side of the Fed’s inflation mandate — full employment. Despite the 4.1% unemployment rate, a 17-year low, there is ample evidence the job market is operating well below full health for most Americans. Among that evidence is the low inflation rate itself, which reflects in part a lack of wage growth.
Maybe the next big Fed conference could focus on those issues instead.