Fed Nears Adoption of an Inflation Target as Bernanke Pushes Transparency
Federal Reserve officials are nearing agreement on adopting an inflation goal as Chairman Ben S. Bernanke extends his push for improving transparency and communications with the public.
“We are very close to having inflation targeting in the U.S.,” James Bullard, president of the Federal Reserve Bank of St. Louis, said in a radio interview yesterday on Bloomberg Surveillance hosted by Tom Keene and Ken Prewitt. “We are getting closer to being able to make a committee-wide statement about these longer-term policy goal issues.”
An explicit numeric inflation objective would mark another step in Bernanke’s unprecedented campaign to open the Fed’s policy process to public view to boost accountability and effectiveness. The Fed chairman has also introduced regular press conferences and will publish the central bank’s own forecasts for the benchmark lending rate this month. At the same time, Bernanke is following a road already taken by central banks from Sweden to New Zealand.
“We’re in a situation where everyone is starting to appreciate the benefits of having the Fed be able to provide clear signals,” said Mark Gertler, a New York University economist and research co-author with Bernanke.
Deciding on the rate of inflation the Fed should shoot for is within reach, said Columbia University economist Frederic Mishkin, who helped shape the Fed’s approach to the question as a governor from 2006 to 2008.
More difficult will be agreeing on how to define full employment, which is also part of the Fed’s marching orders from Congress.
The inflation goal “has been sorted out” by the policy- setting Federal Open Market Committee, said Mishkin, who co- authored a 1999 book with Bernanke on inflation targeting. “The big problem is how you talk about the second part of the dual mandate. There are different views.”
Proponents of adopting an inflation target, such as Federal Reserve Bank of Philadelphia President Charles Plosser, point out that monetary policy directly influences prices. On the other hand, the rate of maximum employment the economy can sustain before wages and prices rise is dependent on other variables, such as the infusion of technology into the economy, which boosts productivity.
Mishkin said economists could argue that estimates for full employment today might range from a jobless rate of 4.5 percent to 7 percent. The unemployment rate unexpectedly fell to 8.5 percent in December, the lowest since February 2009, from 8.7 percent the month before, Labor Department figures showed today.
William C. Dudley, president of the Federal Reserve Bank of New York, said in a speech today that the outlook for unemployment “is unacceptably high relative to our dual mandate and the outlook for inflation is moderate.”
As a result, he said, it’s “appropriate to continue to evaluate whether we could provide additional accommodation in a manner that produces more benefits than costs.”
The 58-year-old Bernanke was a leading advocate of inflation targeting as a Princeton University professor when he co-authored the book “Inflation Targeting: Lessons from the International Experience” with Mishkin, Bank of England Monetary Policy Committee member Adam Posen and economist Thomas Laubach. At his nomination hearing in November, 2005, he said a numeric inflation goal would be a step “toward greater transparency.”
A subcommittee created by Bernanke and headed by Fed Board Vice Chairman Janet Yellen has been looking at ways to improve Fed communications. Its working tool to broker consensus on the dual objective of stable prices and maximum employment is a statement of the committee’s “longer-run goals and policy strategy.”
The statement “would name a target but it would also reiterate things we have said over the years about how keeping inflation low and stable contributes to great economic performance over all,” Bullard said in yesterday’s interview.
Inflation will most likely be expressed in terms of changes to the personal consumption expenditures price index, Bullard said. The index rose 2.5 percent for the 12 months ending November. That’s above the Fed’s longer-run forecast which centers around 1.7 percent to 2 percent.
The presentation may even soften the notion of a target and simply describe a specific level of inflation that would help the Fed achieve its mandate of full employment over time, according to a person familiar with the discussions.
Gertler said a numeric inflation target would serve as both a tactical and transparency tool for the committee. Policy makers should communicate under what inflation conditions they’d start to withdraw their record stimulus, he said. The Fed has kept its key interest rate near zero since December 2008, and last month repeated a pledge to keep it there until at least mid-2013.
“One thing that’s probably worth clarifying is whether the Fed treats the target symmetrically, whether they view 2.5 percent inflation as worse than 1.5 percent inflation,” Gertler said. “As inflation gets to 2 percent, is the Fed going to aggressively tighten? As long as output is low, will they let it creep up?”
Policy makers’ speeches and statements haven’t made that clear, Gertler said. Fed Bank of Chicago President Charles Evans has advocated a promise to keep interest rates low until either unemployment falls below 7 percent or the medium-term inflation outlook rises above 3 percent. Plosser has pushed for an inflation objective of 2 percent.
“The chairman would like to get consensus on this one,” Mishkin said. “It is not easy to get everyone on board.”
FOMC participants “commented” on the draft statement in December, according to minutes of the meeting published this week. Bernanke “encouraged” the communications subcommittee to make refinements and present it to the FOMC again at the Jan. 24-25 meeting.
“Everybody on the committee is in favor of enhanced clarity, and exactly how you do it is the debate,” Gertler said. “They’re slowly making progress.”
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