By Howard Schneider and Trevor Hunnicutt
ATLANTA/NEW YORK (Reuters) – The Federal Reserve is discussing whether a better way to get the U.S. economy to hit the central bank’s inflation target is to tolerate much higher price increases in some years to counter the weaker ones.
One problem: The fact that the Fed has failed for a decade to even reach that 2% level could leave people skeptical it is serious about even more aggressive strategies. That is just one of many hurdles policymakers noted on Tuesday that face any overhaul of the central bank’s policy framework.
“I don’t know if they are really going to believe that we are going to follow through,” Chicago Fed president Charles Evans said at an Atlanta Fed conference. “We have been undershooting 2% for so long… I take it as necessary to go above 2 to be presumed to have credibility,” to deliver under any new approach.
New strategies being debated at the Fed would make up for low inflation with faster inflation in the future, possibly prices increases of as much as 3 or even 4% in some years, Evans said, a level he said markets may be skeptical the Fed would ever allow.
“We identified 2% in 2012 and we have not really hit it since,” Atlanta Fed president Raphael Bostic said. “That raises some questions.”
Bostic said he did not think there was a current bias at the Fed to either change or not change the current system, which targets a 2% annual inflation rate but does not commit the Fed to maintain that as an average over several years.
Other central bankers are making a more urgent case that alternative approaches to such a commitment could help keep the United States from sinking in the quicksand of falling inflation expectations by businesses, financial markets and consumers.
By allowing higher inflation more often, interest rates could also be lifted, giving the Fed more room to cut during a downturn. Additionally, by merely committing to such a system, Fed officials feel they also might coax inflation expectations, and therefore inflation itself, to the 2% level they want to sustain.
“I am worried that we have not done a very good job of persistently getting closer to our 2% inflation target,” Boston Fed President Eric Rosengren said in New York on Tuesday. He said the Fed would be better served by aiming for a range around the target. “I am worried about having enough space in the next recession that monetary policy can offset the negative shock.”
But he said it is possible that the policy review leads to no changes.
Since specifying the target, inflation measured by the Fed’s preferred index has averaged around 1.6%.
Bostic said he had “sympathy for just about every one” of the different frameworks being considered, but that any change will face challenges, particularly in selling the public on it.
“There is a lot of consideration around ease of communication,” he said.
The Fed is holding a series of discussions on the issue, culminating with a research conference in Chicago next month. The central bank may not reach any conclusions on the topic until next year.
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