Inflation goal may be too low, says Rosengren
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Central banks including the Federal Reserve may need to set their inflation goals higher in the future to avoid getting mired in low growth, a senior US policy maker has said.
Eric Rosengren, president of the Federal Reserve Bank of Boston, said in an interview that he wanted to see a debate on the Federal Open Market Committee about whether America’s 2 per cent target was too low.
If inflation targets were set higher, it could mean a higher long-run policy rate, which would mean a bigger cushion to cut rates before hitting the so-called “zero lower bound” for interest rates, he said.
The Fed instituted a formal 2 per cent inflation target in 2012 under former chairman Ben Bernanke, pursuant to a dual mandate under which it seeks maximum employment and price stability. The central bank has not hit its inflation goal since that year, and its target rate has been at near-zero levels since 2008.
“The inflation target was set globally in an environment where most economists thought we were not going to hit the zero lower bound, and if we did, we would be there for a relatively short period of time. Unfortunately that has not been the outcome we have seen,” Mr Rosengren said in a telephone interview after floating the inflation target idea in a speech last week.
“Not only have multiple countries around the world ended up at the zero lower bound but we have yet to have an exit.”
He added: “As we learn more about the real interest rate potentially being lower, we may at least want to have a broader debate about whether we have set the inflation targets too low.”
The argument echoes a call by Olivier Blanchard, the International Monetary Fund’s chief economist, who in 2010 argued that policy makers should shoot for higher inflation to increase the room for monetary policy to react to shocks.
Mr Rosengren, who does not vote on rates this year, said he wanted the level of the US inflation target to be discussed “more explicitly” at the FOMC.
While the Fed had used alternative monetary tools such as quantitative easing to stimulate the economy once official rates were cut to zero, it would be better not to exhaust its traditional interest rate firepower in the first place, he said.
A dove, Mr Rosengren has been urging caution before raising interest rates, given the US is still seeing disappointing economic data.
Since the Fed’s estimates of the longer-run federal funds rate has dropped by around a half to three-quarters of a point since 2012, Mr Rosengren said that may be a starting point for discussing how much the inflation target might be lifted.
Mr Rosengren said that he expected first-quarter US growth to be slower than the 2.2 per cent pace recorded for the end of last year. Risks emanating from overseas — including the renewed turbulence in Greece and the potential for a Chinese slowdown — should play a role in the Fed’s debate about how strong the US recovery will be, he said.
“In addition to the temporary factors from the cold, I think there are international conditions that in some sense have weakened,” he said. “Though we are doing better than many other parts of the world, we are still not doing as well as I would like to see.”
The appreciation of the dollar is also weighing on the US, and the full effects have yet to be manifested, he added. “It is going to take another couple of quarters before the full effects have been felt through the US economy.”
Minutes from the March FOMC meeting showed policy makers were split over the right moment to start tightening monetary policy, with some worrying about the weak numbers that were seen in the first three months of 2015.
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