Tags: fed | better | inflation | target

The Fed Needs a Better Inflation Target

The Fed Needs a Better Inflation Target
Imageegami/Dreamstime

By
Friday, 09 June 2017 07:21 AM Current | Bio | Archive

A group of economists published a letter urging the U.S. Federal Reserve to consider a monumental change in policy: raising its target for inflation above the current 2 percent.

I signed the letter. Here's why.

The inflation target helps define how much stimulus the Fed can deliver when it lowers interest rates to zero (a boundary below which the central bank has been unwilling to go). In a higher-inflation environment, a nominal fed funds rate of zero results in a lower real, net-of-anticipated-inflation rate -- the rate that economists typically see as most relevant for consumer and business decisions. If, for example, people expect inflation to be 3 percent, then a zero nominal rate translates into a negative 3 percent real rate -- a full percentage point lower than the Fed could achieve if expected inflation were 2 percent.

Experience suggests that the Fed could use the added ammunition. During the most recent period of near-zero interest rates, the U.S. unemployment rate remained above 5 percent for nearly seven and a half years (from May 2008 to September 2015). Chair Janet Yellen has suggested that, if another recession takes the Fed to the zero lower bound, the unemployment rate might stay above 5 percent for close to five years. To put it mildly, these aren't desirable outcomes. 

The issue is all the more important because periods of zero nominal rates are likely to be more frequent. In a recent Brookings Institution paper, Fed staffers Michael Kiley and John Roberts conclude that changes in economic conditions -- specifically, a lowering of the "natural" interest rate consistent with full employment and stable inflation -- might require the Fed to be at the zero lower bound about 30 percent to 40 percent of the time.

All this argues for a higher inflation target. But that's not the only change worth contemplating. The Fed should also consider adopting a time horizon for achieving its target -- something many central banks do. Without such a benchmark, the Fed is free to undershoot (or overshoot) for many years at a time. This creates uncertainty that can weigh on economic growth.

Of course, there's also a case against raising the inflation target. That’s why the more important part of the letter is its call for “a diverse and representative commission” to re-examine the monetary policy framework -- a much more open and transparent approach than the Fed usually takes. When the policy-making Federal Open Market Committee (of which I was a member) chose the 2 percent inflation target in January 2012, its deliberations were completely hidden from the public. As a result, the target has little buy-in from the public and Congress.

Canada has demonstrated a better approach. Every five years, its central bank re-examines the monetary policy framework in light of new data and theory, then codifies the framework in an agreement with the government -- that is, with the elected representatives of the people. In the most recent review, the Bank of Canada engaged with the public in many ways, including a lengthy description of the process and a guest post by a high-ranking official on a prominent academic blog. 

The world's most powerful central bank should be able to do at least as well. In light of the past decade's long spell of elevated unemployment and the high likelihood of a recurrence, the Fed should rethink its monetary policy framework. And it should do so in a way that openly engages the American people.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Narayana Kocherlakota is a Bloomberg View columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.

© Copyright 2018 Bloomberg L.P. All Rights Reserved.

   
1Like our page
2Share
NarayanaKocherlakota
In light of the past decade's long spell of elevated unemployment and the high likelihood of a recurrence, the Fed should rethink its monetary policy framework. And it should do so in a way that openly engages the American people.
fed, better, inflation, target
630
2017-21-09
Friday, 09 June 2017 07:21 AM
Newsmax Media, Inc.
 

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved