Fed Officials Encourage Reassessment of Inflation Target -- 2nd Update

By Nick Timiraos Features Dow Jones Newswires

Two Federal Reserve officials said Monday the U.S. central bank should consider changes in its inflation-targeting framework to create more ammunition to respond to future downturns.

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The Fed established a formal 2% inflation target six years ago, but in recent months some officials and other economists, including former Fed Chairman Ben Bernanke, have said the central bank should revisit the framework because interest rates now appear likely to remain much lower for longer. As a result, the Fed could find itself with less room to stimulate economic growth during the next downturn.

The idea of revisiting the Fed's inflation target also has gained new attention because inflation has confounded officials' forecasts for years by consistently falling below the 2% target. Such targets can be less effective if officials are chronically unable to hit them.

Among different ideas, some have urged the central bank to instead target a given level of prices, such as a 2% annual increase.

San Francisco Fed President John Williams argued in favor of a price-level target during a presentation at the Brookings Institution in Washington. Mr. Williams outlined support for such a tool last November.

A price-level target would allow the Fed to make up for periods of below-target inflation by allowing offsetting periods of above-average inflation. This could allow policy makers to provide extra stimulus after the economy recovers from a downturn because officials would signal their willingness to tolerate longer periods of higher inflation.

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Boston Fed President Eric Rosengren said he would prefer adopting an inflation range, rather than a precise target as the Fed currently does, because a range would give the Fed greater flexibility to allow for higher or lower inflation depending on how the economy is performing. He floated an inflation range of 1.5% to 3% as one that might be appropriate.

Others have said even if the Fed doesn't change its framework, it should establish a more formal process to automatically review its inflation target. The Bank of Canada, for example, automatically reviews its inflation target every five years.

Mr. Rosengren said the Canadian approach to periodically assess the inflation target would be useful. The Fed had adopted its current target during a period where it expected interest rates to move away from zero -- and to stay away from the so-called lower bound -- much sooner than they have, he said. "In my own view, the costs of hitting the effective lower bound for a prolonged period should cause a reassessment of the 2% inflation target," Mr. Rosengren said.

Any change would only be effective if officials made a commitment to stay with that framework for a long time, Mr. Williams said, "so that people see that we are following it."

Some other Fed officials have said they are willing to entertain a debate but they don't think changes are warranted. "Let's achieve our 2% objective and then we can have a discussion," New York Fed President William Dudley said in an interview last November.

Some proposals for a temporary price-level target, such as one advocated by Mr. Bernanke, would be difficult to explain clearly to the public, said Mr. Dudley. "This starts to get pretty complicated in terms of communicating," he said.

Deciding to adopt an inflation target followed years of debate for the Fed and was a major initiative of Mr. Bernanke, who became chairman in 2006.

Preparations for the next downturn could become more challenging for the Fed if fiscal policy becomes constrained by rising deficits. A tax cut passed by Congress last month and signed into law by President Donald Trump is projected to raise deficits by $1.5 trillion over the coming decade. The Congressional Budget Office this month said the tax bill could lead the budget deficit to reach 4.9% of gross domestic product by 2020, up from its previous projection of 3.6% before the tax bill had been enacted.

After keeping rates pinned near zero for seven years, the Fed has raised rates five times since December 2015, including most recently last December, lifting the benchmark federal-funds rate to a range between 1.25% and 1.5%. At that meeting, officials said they expected to raise rates three more times this year if the economy performs in line with their expectations.

Officials also projected raising rates to slightly higher than 3% in 2020. While that would be the highest level in more than a decade, the Fed has traditionally cut rates by more than that when the economy contracts.

Fed Chairwoman Janet Yellen, whose term leading the central bank ends next month, has said the Fed isn't entertaining changes to its framework, but minutes from the Fed's December meeting, released last week, show more officials have spoken in favor of studying potential changes.

The decision to take up such a review is likely to fall to Fed governor Jerome Powell, who is President Donald Trump's pick to succeed Ms. Yellen. Mr. Powell joined the Fed's board in May 2012, shortly after the Fed implemented its current framework.

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

January 08, 2018 17:48 ET (22:48 GMT)