Fed Officials Shift Inflation Strategy Even Before Review Ends
The number of policy makers forecasting above-target inflation in three years’ time jumped to seven in December projections.
(Bloomberg) --
The Federal Reserve won’t wrap up a year-long review of its policy framework for months, but some officials are already shifting their approach to hitting the central bank’s inflation goal.
The number of policy makers forecasting above-target inflation in three years’ time jumped to seven in December projections. That looks like a signal they’re deliberately aiming to generate price pressures in excess of their 2% objective. Officials will not be updating their quarterly economic forecasts when they meet Tuesday and Wednesday in Washington, when they are widely expected to leave interest rates unchanged.
There’s also been a noticeable change in the way that some policy hawks, who’ve typically had less tolerance for inflation, now talk about it -- declaring in recent weeks that they’ll be more relaxed about giving inflation time to reach and even exceed the target.
“It is a meaningful shift,” said Julia Coronado, president of MacroPolicy Perspectives LLC in New York. “I certainly think they want it to be seen as a significant change because then that will change people’s views” on what to expect from the central bank that has mostly undershot the inflation goal since it was adopted in 2012.
Still, talk is cheap. As New York Fed President John Williams recently said, “expectations depend on deeds, not just words.”
The ongoing shift -- and the framework review that it accompanies -- is motivated by surprisingly low inflation. Despite unemployment running under 4% for most of the last two years, inflation, as measured by the Fed’s favorite gauge of prices, has languished under 1.5% for almost all of 2019.
‘Fed Listens’
That may not seem like a big deal. Indeed, in a series of “Fed Listens” events in 2019, U.S. central bankers heard loud and clear that most people rather liked the idea of meager price rises. Yet there is a dark side to low inflation, one that could prove painful if the economy takes a sharp downturn.
Low inflation and low growth together mean interest rates are also low, and that robs the Fed of ammunition it may need to fight off a recession. At the moment, the Fed’s benchmark rate sits close to 1.5%. Since World War II the Fed has reacted to recessions by lowering rates, on average, by about 5 percentage points. In other words, the Fed is likely to hit zero before it can provide sufficient fuel for a rebound.
That’s why the Fed began a wholesale review in 2019 to ask whether its current strategies, tool kit and communications need revamping. Chairman Jerome Powell says he expects the review to conclude in mid-year.
Few anticipate radical change, like a formal adoption of a so-called make-up strategy that obliges officials to counter an extended miss on one side of the inflation target with another extended miss on the other side.
Raising Eyebrows
JPMorgan Chase & Co.’s chief U.S. economist, Michael Feroli, is among those predicting the Fed will adopt something vague -- endorsing the idea of getting inflation to average closer to 2% over time without binding future Fed actions.
That would still be meaningful. Current policy declares the Fed will seek to move inflation toward its 2% target regardless of past misses. Fed Vice Chairman Richard Clarida continued to confirm this policy of letting bygones be bygones last year.
But the recent set of inflation projections from the Fed suggest some officials may be making a shift by raising inflation projections above target two and three years into the future. It’s not unusual for some officials to forecast off-target inflation, but the appearance of seven officials predicting an overshoot in 2022 is raising eyebrows.
“This basically is the make-up strategy idea” already showing itself, said Roberto Perli, a partner at Cornerstone Macro LLC in Washington. “They are saying they want higher inflation going forward because we have missed constantly for the last several years.”
Defining Symmetric
Another telling moment came Dec. 18 when Williams provided his definition of the Fed’s “symmetric” 2% goal.
“I really see this notion that we’re on average around 2% inflation, sometimes a little bit above, sometimes below, and that’s what I think the word symmetric means,” he said.
Seems reasonable, except it’s not really what the Fed meant when it introduced that word to its longer-run strategy statement in 2016. Back then it was meant to emphasize that the 2% target was not intended to be a ceiling. It was not, as Clarida has made clear as recently as November, an abandonment of the “bygones” strategy, as Williams appeared to describe it.
“What we’re getting is language that makes clear that they’ve left the bygones era behind,” Coronado said.
Let it Run
Even for those policy makers who would not willfully shoot for above-target inflation, there seems to be growing appetite for letting the economy run hotter for longer to lift inflation expectations.
“I know I’ve been over-optimistic on inflation,” Cleveland Fed President Loretta Mester, considered one of the more hawkish officials, said in a Jan. 3 interview. “So I look at that and say, you know what, I’m going to allow this to go a little longer.”
Carrying through with such a stance will take some resolve, and her Boston Fed colleague Eric Rosengren, for one, is already voicing worry over inflation risks.
“There will be a chorus of voices putting some pressure on them to at least do something in 2021,” said Michael Gapen, chief U.S. economist at Barclays Plc in New York. Still, he believes this time, policy makers will hold off from acting too soon. “I think they’ll be able to do it.”
To contact the reporter on this story: Christopher Condon in Washington at ccondon4@bloomberg.net
To contact the editors responsible for this story: Margaret Collins at mcollins45@bloomberg.net, Alister Bull
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