A day after rolling out a new strategy for U.S. monetary policy, Federal Reserve officials on Friday diverged over what it might mean in practice, saying there is no exact formula for the average inflation rate they plan to target.
While the aim of the new strategy is to allow higher inflation and, as a side-effect, additional job growth over time, Fed policy-makers differed over just how much more inflation they will tolerate or what metrics they will be looking at – a complication for investors or households setting expectations about the future.
Dallas Fed President Robert Kaplan said he would be comfortable with inflation running a “little bit” above the Fed’s 2 per cent inflation target if the economy were to once again be running near full employment.
“And for me, a little bit means a little bit,” or about 2.25 per cent, Kaplan said during an interview with Bloomberg TV. “I still think price stability is the overriding goal and this framework doesn’t change that.”
St. Louis Fed President James Bullard, who along with Kaplan and their 15 policy maker colleagues will carry out the Fed’s new strategy, had a different answer.
“Inflation has run below target, certainly by half a per cent, for quite a while, so it seems like you could run above for a half a per cent for quite a while,” Bullard told CNBC.
And Philadelphia Fed President Patrick Harker had yet another view.
“It’s not so much the number. ... It’s really about the velocity,” Harker said during a separate interview with CNBC, adding that inflation “creeping up to 2.5 per cent” is different from inflation that is “shooting past 2.5 per cent.”
The Fed announced on Thursday that its inflation target would be based on an average over time rather than a hard annual target, as had been the case since 2012, an approach that it said would make it likely to aim for too-high inflation for a time to make up for what has been years of too-low inflation.
The disconnect among policy-makers underscores the big question – what to expect when you are expecting higher inflation?
Recognizing when inflation has risen too much will depend on what else is happening with the economy, Cleveland Fed President Loretta Mester said. “This isn’t really tied to a formula,” Mester said in an interview with CNBC, nodding to Fed Chair Jerome Powell’s speech on Thursday in which he laid out the new strategy. “It’s really going to depend on what’s going on with the economy and how stable your inflation expectations are.”
‘MORE PAIN OUT THERE’
The comments by the Fed policy-makers reflected, in part, the longer-term thinking behind the strategy document, crafted not to bind decisions at individual Fed policy meetings but to frame how the central bank is setting priorities.
Convincing the public that it makes a difference will only happen over time – a challenge that will need to survive developments in the economy and the inevitable shifts in Fed personnel, including a possible new chief after the Nov. 3 U.S. presidential election.
Some analysts were skeptical the Fed’s new strategy would help it reach its elusive 2 per cent inflation target, or that policy-makers would really be tolerant of higher inflation if and when it arrives.
Inflation has run short of the Fed’s goal since the target was adopted in 2012. By announcing that it will try to meet the target on average, with spells of higher inflation encouraged to make up for periods of weak price rises, the Fed hopes to reset market and household psychology to expect higher prices, and act in ways that will help deliver them.
But “when it comes time to run hot, will the Fed actually be able to follow through?” asked David Beckworth, a senior research fellow at the Mercatus Center at George Mason University and a former international economist for the Treasury Department.
“We will wait and see. If the makeup windows are not defined, it could boil down to a ‘nothing burger,’” Beckworth said of the fact that the new strategy does not nail down a timeline over which average inflation will be monitored.
Fed officials did not offer specifics this week for how the new strategy would be enacted, or whether it would lead to additional asset purchases or forward guidance.
Kaplan noted on Friday that policy-makers have made clear that interest rates will not rise for a long time, and said he prefers to wait before issuing more forward guidance. “I would prefer to get more clarity on the path of the virus,” and how well the economy does during the ongoing COVID-19 pandemic, Kaplan said.
Policy-makers stressed that the U.S. economic recovery was likely to be slow and would need more fiscal and monetary policy support.
The labour market is “basically moving sideways” and a lot of the jobs in the retail, tourism and travel sectors are not going to come back in the same way, Harker said, predicting the economy’s recovery would not be a steady curve upwards but would look like a “a very bumpy Nike swoosh.”
“I do believe the recovery is going to be a slow one,” Mester said. “I do think that there’s more pain out there that we’re going to have to support the economy through.”
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