The Federal Reserve should stop relying on an inflation measure that excludes volatile food and energy prices as a way to assess price pressures and focus instead on overall price increases, a top Fed official said.
Shifting the Federal Reserve's focus away from core inflation, which strips out food and energy prices, would reconnect the U.S. central bank with the households and businesses impacted by the price changes, James Bullard, president of the St. Louis Federal Reserve, said.
"It is time to drop the emphasis on core inflation as a meaningful way to interpret the inflation process in the U.S.," Bullard said in an address to the Money Marketeers of New York University.
"With trips to the gas station and the grocery store being some of the most frequent shopping experiences for many Americans, it is hardly helpful for Fed credibility to appear to exclude all those prices from consideration in the formation of monetary policy," he said.
Main Street's view that the Fed is out of touch was highlighted in March when the president of the New York Fed, William Dudley, used the iPad as an example of price trends in a speech in Queens, a largely working class borough of New York.
There has been less emphasis on core inflation, he later added that, largely due to a pushback from mainstream America.
Bullard also advocated for the Fed to set an explicit inflation target, as other central banks around the world do.
Assessing inflation is a key component in the Fed's decisions on monetary policy.
A recent surge in the prices of oil and other commodities ranging from corn to wheat has raised questions about how much U.S. households manage a squeeze on their wallets before they are forced to curb other spending — a move that some fear could hurt an already fragile economic recovery.
Bullard said that while headline inflation tends to be more volatile than other measures, the Fed can adjust any policy response to take such volatility into consideration.
He repeated recent statements that the Fed can afford to pause after the end of its latest round of quantitative easing to assess the economy's strength before tightening monetary policy. Fed's purchase of $600 billion in assets is scheduled to be completed next month.
"We can afford to wait and see. It would be a good time to gather information on the economy and see how things are developing," Bullard told reporters following the speech.
When the Fed does begin to tighten policy again, Bullard said his preference would be to start with reducing the central bank's balance sheet, either by allowing assets to mature or by selling them.
Earlier Wednesday, minutes of the Fed's April policy meeting showed officials prefer to raise rock-bottom interest rates before selling assets when the time comes to tighten policy.
Fed policy makers are trying to distinguish between increases in more visible prices such as food and gasoline and a broader underlying trend of cost rises that could prompt a move to higher interest rates.
Bullard said it is not a given that the recent run-up in energy and other commodity prices is temporary — as the Fed largely believes.
"It is certainly true that we should not expect energy prices to increase faster than the general price level without limit." he said. "But it is also true that there are well-known examples of long-term secular trends in certain prices."
If global demand for energy outstrips increased supply in the coming decades as Asian economies grow, ignoring energy prices will systematically understate inflation for many years, he said.
Oil and other commodity prices have seen a pullback in recent weeks after a sudden spike amid geopolitical tensions around the world.
In regards to commodity prices, Bullard said it was reasonable to say headline inflation looks high now and will come back down in future, but over a longer period of time it was possible prices would increase faster than inflation, leaving a gap between core and headline inflation.
Data released last week showed U.S. consumer prices rose to a 2-1/2-year high of 3.2 percent in the 12 months to April, though core inflation was only 1.3 percent.
The pace of food and fuel price rises, however, slowed from the month before, suggesting inflation pressures may be peaking.
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