Brainard Suggests Fed Let Inflation Overshoot 2% Target
Federal Reserve Governor Lael Brainard suggested that the U.S. central bank might adopt a strategy of “opportunistic reflation’’ in which it accepts a slight overshoot of its 2% inflation target for a while, even if trade tensions are behind price increases.
The aim of such an approach would be to lift underlying inflation up to 2% and underscore the Fed’s commitment to that objective, she said Thursday in a speech to the National Tax Association in Washington.
“Suppose that an unexpected increase in core import price inflation drove overall inflation modestly above 2% for a couple of years,’’ Brainard said. “The Federal Reserve could use that opportunity to communicate that a mild overshooting of inflation is consistent with our goals and to align policy with that statement.’’
Brainard’s reference to higher import prices may not be entirely coincidental. The import tariffs that President Donald Trump is levying on shipments from China and elsewhere are likely to put upward pressure on inflation.
Such a strategy would be the mirror image of the “opportunistic disinflation’’ strategy successfully pursued by former Fed Chairman Alan Greenspan, who did not seek to actively push inflation down but took advantage of periods when it did fall to lock it in at lower levels. The difference now is that the Fed worries about inflation being too low rather than too high.
The Fed has failed to convincingly lift inflation to its 2% target since the objective was adopted in 2012. In March, prices rose just 1.5% from the year-ago level, according to the Fed’s favorite inflation gauge.
Absent such shocks as a rise in import prices, Brainard said it was “not entirely clear’’ how the Fed could raise inflation on a sustained basis given how unresponsive it is to low unemployment.
“The emerging contours of today’s new normal are defined by low sensitivity of inflation to changes in labor market slack, a low long-term neutral rate of interest, and low underlying trend inflation,’’ she said.
That’s a world that might be more susceptible to asset bubbles and other financial excesses, Brainard said.
“With the forces holding down interest rates likely to persist, valuation pressures and risky corporate debt, such as leveraged lending, could well remain at elevated levels,’’ she said.
Brainard said the Fed should lean against such excesses through financial regulation and supervision and specifically cited the central bank’s counter-cyclical capital buffer as one measure that could employed in that way.
The Fed decided in March against activating the buffer -- a tool that would require big banks to set aside extra money to absorb potential loan losses. The central bank’s board voted 4-1 to keep the buffer at zero, with Brainard lodging the only dissent.
She also warned against any loosening financial regulations and oversight.
“Now is a bad time to be weakening the core resilience of our largest banking institutions or to be weakening oversight over the non-bank financial system,'' said Brainard, who was appointed to the Fed by then-President Barack Obama in 2014.
Speaking separately Thursday in Santa Barbara, California, Minneapolis Fed President Neel Kashkari effectively argued that the central bank itself was at fault for the low level of inflation.
“Monetary policy has been too tight in this recovery, resulting in a slower economic recovery than necessary and low inflation expectations, which directly saps the Fed’s ability to respond to a future downturn,” he said.
Kashkari, one of the Fed’s more dovish policy makers, echoed Brainard’s support for an inflation overshoot.
“For our current framework to be effective and credible, we must walk the walk and actually allow inflation to climb modestly above 2% in order to demonstrate that we are serious’’ about the target, he said.
Brainard indicated that it might not take all that long to lift underlying inflation up to the Fed’s objective.
“Our goal may be achievable if inflation moves only slightly above 2% for a couple of years,’’ she said.
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