The Federal Reserve needs to attack the risk of deflation just as it would fight too much inflation, Minneapolis Fed President Narayana Kocherlakota said Friday in explaining his vote against ending the central bank's six-year stimulus to the American economy.
In a statement, he said the Fed's credibility is at risk because it is not "taking more purposeful steps to move inflation back up to 2 percent," its publicly stated target.
Low inflation, and particularly deflation, can impede economic growth because consumers and businesses tend to delay spending in the expectation of lower prices.
When the Fed last December began tapering its bond-buying stimulus campaign, Kocherlakota and other members of its policymaking committee issued a statement saying they would be "monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term."
On Friday, he wrote, "At this stage, I see no such evidence. In my assessment, the medium-term outlook for inflation has shown no overall improvement since last December and, indeed, is arguably worse. Failing to act in response to this subdued inflation outlook increases the downside risk to the credibility of our 2 percent inflation target."
The other members of the policy committee on Wednesday voted to end the bond-buying program, which began in 2008 and has put trillions of dollars of bonds onto the balance sheet of the Fed. The end of the campaign was seen as a symbolic turning point in the protracted recovery of the U.S. economy from the deep downturn that began in 2008.
Kocherlakota's dissent wasn't surprising. For weeks, he has spoken publicly about risks of low inflation and deflation and his worry that businesses, investors and consumers will begin to doubt the Fed's effort to bring inflation up to the 2 percent level.
In his statement, Kocherlakota suggested two steps the Fed could take to signal it wants inflation to rise. It could continue buying $15 billion worth of bonds a month and it could declare interest rates will stay at their current ultralow level "at least until the one- to two-year-ahead inflation outlook has risen back to 2 percent, as long as risks to financial stability remain well-contained."
"These actions would have put upward pressure on the demand for goods and services and on prices," Kocherlakota said. "Just as importantly, these actions would have communicated that the committee is determined to do what it takes to push inflation back to 2 percent as rapidly as is possible."
In the statement, Kocherlakota also cited the difficulty that Japan's central bank has had fighting deflation, and he suggested similar difficulties may be appearing in Europe.
Earlier Friday, the Bank of Japan made a surprise announcement that it would increase its annual asset purchases to as much as 80 trillion yen, about $725 billion, to boost that country's economy. Japan's giant pension fund, the world's largest, also said it would move more aggressively into stock investing.
Both moves lifted sentiment for stocks around the world. On Wall Street, the benchmark Dow Jones industrials and Standard & Poor's 500 indexes closed at record highs Friday.
"Central banks need to take actions on an ongoing basis to ensure that inflation stays at target," Kocherlakota said. "In light of the evolution of the data over the past few months, I believe we needed to take such actions on Wednesday."