By Steven K. Beckner
(MNI) – Given widespread concern and uncertainty about the outlook
for inflation, now is “an opportune time” for the Federal Reserve to
adopt an explicit, numerical inflation target, Cleveland Federal Reserve
Bank President Sandra Pianalto argues in an essay released Tuesday.
Pianalto, writing in the Cleveland Fed’s annual report, says a 2%
medium-term inflation target would help anchor inflation expectations,
would help the Fed explain an eventual tightening of monetary policy and
would facilitate meeting its “dual mandate” of price stability and
maximum employment.
Pianalto does not indicate that monetary tightening is needed soon.
Although “the economy has gained a firmer footing” and “inflation
concerns are mounting,” she writes that “too many Americans are still
hurting–many are out of work, many have seen the values of their homes
plummet, and many see little hope of restoring their nest eggs for
retirement.”
She says she will be “keeping a close eye on signs of inflation.”
But Pianalto, who is not a voting member of the Fed’s policymaking
Federal Open Market Committee this year, mostly focuses on the
longer-term need for an explicit inflation target.
“I think it is an opportune time for the FOMC to establish an
explicit inflation objective,” she writes. “The potential benefits are
large and, in my mind, likely to help foster the Federal Reserve’s
objectives of price stability and maximum employment.”
“Specifically, I favor establishing a 2% inflation objective,” she
says. “In the interest of economic stability, and to provide some
flexibility to respond to shocks, our intention would be to move as
close as possible to this target annually.”
Pianalto proposes that “in the event of shocks to the economy that
push inflation away from this target, the goal would be to set policy so
that inflation converges back to 2% over the medium term, a period of
perhaps two to four years, depending on the size of the shocks.”
She argues that “the potential merits of a stated inflation
objective seem particularly large at the moment, given the array of
challenges bearing down on the economy so far in 2011.”
For one thing, uncertainty about future inflation rates presents a
problem, she observes. “Even though underlying inflation today is still
at a low level, people disagree about where it is heading,” she says.
“Even professional forecasters differ more with one another about the
longer-run inflation outlook now than they did before the recession.”
This uncertainty about inflation exists, she says, because “with
unemployment very high and wages increasing very slowly, underlying
inflation could remain subdued.” But at the same time, “recent increases
in energy and other commodity prices are putting upward pressure on
inflation.”
“Although these pressures have not spilled over into consumer
prices more generally, it is possible that they could,” she writes.
And Pianalto suggests that there is a degree of distrust about the
Fed’s willingness and/or ability to control inflation that could be
dissuaded through adoption of an inflation target.
“Although I trust that the FOMC will act as needed to preserve
price stability, the perceived threat of inflation is very real in many
people’s minds,” she notes. “They see the expansion of the Federal
Reserve’s balance sheet, the federal government’s immense borrowing
needs, and rising global commodity prices as all potentially
contributing to rapidly rising inflation.”
Pianalto warns that “if those concerns intensified so strongly that
broad measures of longer-term inflation expectations escalated, actual
inflation could rise in the absence of an appropriate response from the
Federal Reserve.”
Like many of her colleagues she stresses the importance of
inflation expectations in keeping inflation itself under control and
suggests that they are at risk of coming unmoored.
“Rising long-term inflation expectations (one of the key
determinants of the actual inflation trend) could push inflation
higher,” she writes. “For example, expectations of a pickup in inflation
could lead firms to boost their prices to reflect those expectations,
contributing to a rise in inflation this year.”
An inflation target could precent that, she maintains.
“In these circumstances, the FOMC’s adoption of a concrete,
explicit numerical objective for inflation could be advantageous,” she
writes, pointing to the successful experience of other central banks.
“In countries with explicit inflation targets, private-sector
forecasters are in greater agreement about the inflation outlook.”
Pianalto says there would be three main, intertwined gains from a
numerical target:
“First, better-anchored inflation expectations could increase the
Federal Reserve’s ability to adjust monetary policy to stabilize the
economy.”
“For example, when the economy is weak, the FOMC could have more
scope to ease monetary policy without triggering an increase in
longer-term inflation expectations that would put upward pressure on
inflation,” she continues. “The explicit objective for price stability
would help to assure the public that a more expansive monetary policy
was a temporary move to stabilize the economy, without any implications
for the longer-run inflation objective. Thus, an explicit numerical
inflation objective could boost the stability of employment as well as
inflation.”
Second, “an explicit numerical objective for inflation could also
enhance the accountability and transparency of monetary policy. With a
numerical objective, the public would know exactly what inflation
outcome the FOMC was trying to achieve. The public would then be better
able to evaluate the FOMC’s performance.”
She says Fed chairman Ben Bernanke’s semiannual reports to Congress
“would likely include a discussion of inflation outcomes relative to the
objective. Less routinely, one can imagine Congress asking the chairman
to testify regarding the reasons why inflation had drifted from the
target for an unusual length of time.”
Third, “putting a number on the FOMC’s inflation objective would
help the FOMC explain its actions to the public.”
If the Fed had had a 2% inflation target when the FOMC launched a
second round of quantitative easing last November, Pianalto contends
that “having had such an objective might have allowed the FOMC to better
explain the expansion of its purchases of longer-term Treasury
securities.” She added, “I think the FOMC could have been clearer about
its motivation to engage in large-scale asset purchases if it had been
able to reference its 2% inflation objective.”
Looking ahead, Pianalto writes that “having an explicit numerical
objective for inflation would help the FOMC explain its eventual
decision to tighten monetary policy.”
“For instance, once the economic recovery is sufficiently far along
that the FOMC expects inflation to begin gathering some momentum, I
think the timing and magnitude of our actions to tighten policy would be
more clearly understood by the public if we could reference a numerical
inflation objective,” she continues. “This would be especially useful in
the context of the FOMC’s already-established practice of publishing its
economic projections.”
“Likewise, an explicit objective might put to rest the media trope
about inflation ‘hawks’ and ‘doves,’ as it would be evident that all
members shared the identical objective,” she adds.
** Market News International **
[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]
