The president of the Federal Reserve Bank of Minneapolis said Wednesday that even when inflation hits the Fed’s current 2 percent target, it may still not be high enough.
Local Fed leader Narayana Kocherlakota suggested that the Fed should consider a policy that would get prices up to a level they would have reached if inflation had been higher in recent years. Signaling that approach, he said, could stimulate economic growth and help a job market that is still too weak.
Inflation has averaged 1.3 percent since 2012, well below the 2 percent target the Fed set two years ago and an indication that monetary stimulus has not been sufficient to get the economy moving, he said. The Fed’s forecasts don’t foresee inflation hitting the 2 percent target until 2018.
“If the FOMC simply targets a 2 percent inflation rate after 2018, then the price level will be permanently 2.5 percent lower than was expected in 2012,” Kocherlakota told the Economic Club of Minnesota. “The FOMC could target a slightly higher inflation rate for a few years after 2018 in order to make up for the shortfall.”
While low inflation helps consumers with everyday purchases, it also holds down wages and the value of assets like homes. A price target instead of an inflation target would make long-term contracts safer for borrowers and lenders, Kocherlakota said, and would stimulate long-term economic growth.
Kocherlakota was careful to say he does not necessarily support price level targeting, but believes it should be the subject of a “policy conversation.”
His new idea is in line with his position that the Federal Reserve should do more to improve the economy. He was the lone dissenter to the statement on the economy that the Federal Open Market Committee released in March because, he said, it didn’t offer explicit enough assurances that the central bank would use monetary policy to drive inflation back up to 2 percent.
Typically, a low interest rate policy from the Fed should lead to more economic activity and thus higher inflation. But the Fed has been easing up on a bond-buying program, known as quantitative easing, that was intended to keep interest rates low and stimulate spending and investment.
While the national unemployment rate is falling, however, Kocherlakota said this is a function of fewer people looking for work.
“Most of the declines in the unemployment rate since October 2009 have occurred because the fraction of people who are looking for work has fallen,” he said Thursday.
Kocherlakota believes the Fed is “underperforming” both because of the weakness of the job market and because inflation — as measured by the personal consumption expenditures index — has been running well below the Fed’s target of 2 percent and is expected to remain low for several years.
“The undershooting is problematic in part because it suggests the American economy is wasting available resources, especially its human resources,” he said.