Fed Officials Revive Discussion of Explicit Inflation Target
By Craig Torres and Steve Matthews
Jan. 7 (Bloomberg) -- Federal Reserve officials revived the prospect of setting an explicit target for inflation to counter the risk that the worst economic slump in the postwar era will trigger a broad decline in prices.
The Federal Open Market Committee at its Dec. 15-16 meeting discussed ways to avert deflation while approving a reduction in the benchmark interest rate to as low as zero, according to minutes of the gathering released yesterday. The FOMC also considered increasing emergency loans that have doubled the Fed’s balance sheet to $2.3 trillion in the past year.
Policy makers “face considerable uncertainty about how inflation expectations could evolve,” said Brian Sack, deputy director at Macroeconomic Advisers LLC in Washington and a former Fed economist. “That enhances the argument for taking the further step and adopting an explicit inflation objective.”
By setting a goal for price increases, the central bank would adopt a measure that the U.K., Sweden and other countries have used to anchor policy and build credibility with the public. Chairman Ben S. Bernanke made a target one of his priorities when he took the helm three years ago, though a 2007 review of Fed communications stopped short of that objective. Now, with inflation retreating and the economy contracting, a target could be used to justify a more expansive policy.
One measure of inflation, the personal consumption expenditures price index, minus food and energy, could rise at less than 1 percent this year, and only 0.5 percent in 2010, according to forecasts by Sack’s firm.
‘More Explicit’
Central bank officials discussed providing “a more explicit indication of their views on what longer-run rate of inflation would best promote their goals of maximum employment and price stability,” the minutes said. Such a target may “help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low.”
An inflation goal would reinforce expectations that the central bank will make a commitment to withdraw cash when the economy shows signs of a recovery.
Some policy makers last month saw “significant risks that inflation could decline and persist for a time at uncomfortably low levels,” the minutes said. Price increases will probably “continue to abate because of the emergence of substantial slack in resource utilization and diminishing pricing power.”
Fed officials saw “substantial” risks to the slumping economy last month and indicated “the economic outlook would remain weak for a time and the downside risks to economic activity would be substantial,” according to the minutes.
‘Dark Document’
“Rates are going to be low for a long time,” said Vincent Reinhart, former director of the Fed’s Division of Monetary Affairs, who is now a visiting scholar at the American Enterprise Institute in Washington. “They see the economy as extremely weak. It is a dark document.”
Economic growth declined in the third quarter at the fastest rate since 2001 as unemployment rose and home values, housing starts, auto production and consumer spending fell. Analysts downgraded forecasts last month, with economists at Morgan Stanley and JPMorgan Chase & Co. predicting a contraction in gross domestic product of about 6 percent for the fourth quarter, the biggest decline in 26 years.
“The current downturn is likely to be far longer and deeper than the ‘garden-variety’ recession,” Federal Reserve Bank of San Francisco President Janet Yellen said in a Jan. 4 speech. “It’s worth pulling out all the stops” in a fiscal stimulus.
U.S. employment fell by 500,000 jobs in December, bringing last year’s decline to 2.4 million, the most since 1945, according to the median estimate of economists surveyed by Bloomberg News ahead of Labor Department figures due Jan. 9.
Alternative Tools
Policy makers discussed an array of alternative policy tools at the meeting last month, including communicating their expectations for interest-rate changes and expanding the balance sheet by taking on more loans and bonds that private creditors refuse to hold.
The FOMC also discussed setting a target for growth in measures of money, such as the monetary base. While a “few” policy makers favored a numerical goal for money growth, most preferred a more open-ended “close cooperation and consultation” with the Fed board on how to expand assets and liabilities.
“Going forward, consideration will be given to whether various quantitative measures would be useful in calibrating and communicating the stance of monetary policy,” the minutes said.
The central bank will have difficulty scaling back its auction of loans and other emergency programs without upsetting the bond market, former St. Louis Fed President William Poole said in a Bloomberg Television interview.
‘Substantial Reaction’
“The market will take that as being a signal that monetary policy is tightening and that is going to set off substantial reaction in the bond market, maybe the equity markets too,” Poole said.
President-elect Barack Obama yesterday called for a record stimulus to prevent the recession from deepening. His plan aims to create or save 3 million jobs and may cost about $775 billion.
Policy makers discussed “possible refinements to the committee’s approach to projections,” including providing more information about individual views on “longer-run sustainable rates” of unemployment, inflation and economic growth.
The committee, after Bernanke’s urging, started publishing three-year forecasts for growth, inflation and unemployment in the minutes of the October 2007 FOMC meeting.
The third year of those projections is viewed by analysts as a signal of policy makers’ preferences for prices, unemployment and growth. The third-year projection may be less valuable in communicating goals because slack in the economy may continue to depress inflation through 2011, Sack said.
Fed considers setting inflation target
By Krishna Guha in Washington
Published: January 6 2009 21:45 | Last updated: January 6 2009 21:45
The Federal Reserve is eyeing establishing a de facto inflation
target, minutes of its groundbreaking December policy meeting revealed
on Tuesday.
The idea would be to shore up the public expectations of positive
inflation and so make it less likely that a deflationary dynamic could
take hold as the US recession deepens.
Policymakers discussed the possibility of offering a "more explicit
indication of their views on what longer-run rate of inflation would
best promote their goals of maximum employment and price stability".
They reasoned that the "added clarity in that regard might help
forestall the development of expectations that inflation would decline
below desired levels".
The minutes provide further insight into the meeting at which the Fed
cut its target interest rate to virtually zero and laid out its
strategy for unconventional easing.
They also reveal that Fed staff economists now expect the US economy
to contract in 2009 as a whole, with a sharp decline in the first half
and a slow recovery in the second.
Fed policymakers "generally agreed" that the "downside risks to even
this weak trajectory for economic activity were a serious concern".
Some thought there was a "distinct possibility of a prolonged
contraction".
They were "uncertain about the extent to which inflation would fall" –
with some worried that it might decline to levels inconsistent with
medium-term price stability.
The minutes also show the committee wanted the public to know that it
expects short-term interest rates "to stay exceptionally low for some
time" – but that this statement was conditional, based on the
evolution of the economic outlook.
Officials debated whether it might be helpful to set a target for the
quantity of bank reserves – as in Japan during its period of
quantitative easing in the early 2000s – and resolved to consider this
further.
However, the minutes make it clear that their policy is driven by the
"quantity and the composition of Federal Reserve assets" – loans and
asset purchases – rather than reserves and other liabilities.
Officials discussed the merits of purchasing large quantities of
securities issued by Fannie Mae and Freddie Mac, the
government-controlled mortgage giants, and Treasuries. They reasoned
that such purchases would indirectly reduce borrowing costs for
private borrowers – but "participants were uncertain as to the likely
size of those effects".
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Prof. Benjamin Shalom Bernanke Exposed
"The debate about the ultimate causes of the prolonged Japanese slump has been heated. There are questions, for example, about whether the Japanese economic model, constrained as it is by the inherent conservatism of a society that places so much value on consensus, is well-equippedto deal with the increasing pace of technological, social, and economic change we see in the world today.
The problems of the Japanese banking system, for example, can be interpreted as arising in part from the collision of a traditional, relationship-based financial system with the forces of globalization, deregulation, and technological innovation (Hoshi and Kashyap, forthcoming). Indeed, it seems fairly safe to say that, in the long run, Japan’s economic success will depend largely on whether the country can achieve a structural transformation that increases its economic flexibility and openness to change, without sacrificing its traditional strengths.
In the short-to-medium run, however, macroeconomic policy has played, and will continue to play, a major role in Japan’s macroeconomic (mis) fortunes. My focus in this essay will be on monetary policy in particular. Although it is not essential to the arguments I want to make—-which concern what monetary policy should do now, not what it has done in the past—-I tend to agree with the conventional wisdom that attributes much of Japan’s current dilemma to exceptionally poor monetary policy-making over the past fifteen years (see Bernanke and Gertler, 1999, for a formal econometric analysis).
Among the more important monetary-policy mistakes were 1) the failure to tighten policy during 1987-89, despite evidence of growing inflationary pressures, a failure that contributed to the development of the “bubble economy”; 2) the apparent attempt to “prick” the stock market bubble in 1989-91, which helped to induce an asset-price crash; and 3) the failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously
Bernanke and Gertler (1999) argue that if the Japanese monetary policy after 1985 had focused on stabilizing aggregate demand and inflation, rather than being distracted by the exchange rate or asset prices, the results would have been much better. Bank of Japan officials would not necessarily deny that monetary policy has some culpability for the current situation. But they would also argue that now, at least, the Bank of Japan is doing all it can to promote economic recovery.
For example, in his vigorous defense of current Bank of Japan (BOJ) policies, Okina (1999, p. 1) applauds the “BOJ’s historically unprecedented accommodative monetary policy”. He refers, of course, to the fact that the BOJ has for some time now pursued a policy of setting the call rate, its instrument rate, virtually at zero, its practical floor. Having pushed monetary ease to 2 Posen (1998) discusses the somewhat spotty record of Japanese fiscal policy; see especially his Chapter 2.its seeming limit, what more could the BOJ do? Isn’t Japan stuck in what Keynes called a “liquidity trap”?
I will argue here that, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan. Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively. However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections—- objections which, I will argue, could be overcome if the will to do so existed.
My objective here is not to score academic debating points. Rather it is to try in a straightforward way to make the case that, far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism."
Prof. Benjamin Shalom Bernanke
Japanese Monetary Policy: A Case of Self-Induced Paralysis?
For presentation at the ASSA meetings, Boston MA, January 9, 2000.
A Credit Free, Free Market Economy will correct all of those dysfunctions.
The alternative would be, on the long run, to wait for the physical destruction (through war or rust) of most of our productive assets. It will be at a cost none of us can afford to pay.
This Age of Turbulence People Want an Exit Strategy Out of Credit,
An Adventure in a New World Economic Order.
A Specific Application of Employment, Interest and Money [For Economists].
Press release of my open letter to Chairman Ben S. Bernanke:
Sorry, Chairman Ben S. Bernanke, But Quantitative Easing Won't Work.
Yours Sincerely,
MC Shalom P. Hamou
Chief Economist & Master Conductor
1776 - Annuit Cœptis.
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