- Andrew Medichini/AP
Federal Reserve Chair Janet Yellen had a surprising answer to the question of what she thought of a recent proposal by 22 prominent economists for the central bank to raise its 2% inflation target given the economy’s subdued recent track record: she didn’t knock it down.
That’s what she had normally done when asked about the prospect of raising the Fed’s inflation target. This time, she seemed downright open to the idea.
Here was Yellen in September 2015, in a footnote to a speech on “Inflation Dynamics and Monetary Policy” (emphasis ours):
“It is not obvious that a modestly higher target rate of inflation would have greatly increased the Federal Reserve’s ability to support real activity in the special conditions that prevailed in the wake of the financial crisis, when some of the channels through which lower interest rates stimulate aggregate spending, such as housing construction, were probably attenuated. Beyond these tactical considerations, however, changing the FOMC’s long-run inflation objective would risk calling into question the FOMC’s commitment to stabilizing inflation at any level because it might lead people to suspect that the target could be changed opportunistically in the future. If so, then the key benefits of stable inflation expectations discussed below – an increased ability of monetary policy to fight economic downturns without sacrificing price stability – might be lost. Moreover, if the purpose of a higher inflation target is to increase the ability of central banks to deal with the severe recessions that follow financial crises, then a better strategic approach might be to rely on more vigorous supervisory and macroprudential policies to reduce the likelihood of such events. Finally, targeting inflation in the vicinity of 4% or higher would stretch the meaning of ‘stable prices’ in the Federal Reserve Act.”
In other words: Not a great idea. Now here’s what Yellen had to say on the issue in August 2016. She sounded less hesitant but still not ready (emphasis ours):
“Some observers have suggested raising the FOMC’s 2% inflation objective or implementing policy through alternative monetary policy frameworks, such as price-level or nominal GDP targeting. I should stress, however, that the FOMC is not actively considering these additional tools and policy frameworks, although they are important subjects for research.”
At her press briefing June 14, Yellen was singing a different tune.
“At the time that we adopted the 2% target was back in 2012, we had a very thorough discussion of the factors that should determine what our inflation objective should be. I believe that was a well thought out decision. Now, at the moment, we are highly focused on trying to achieve our 2% objective, and we recognize the fact that inflation has been running below and it’s essential for us to move inflation back to that objective. Now, we have learned a lot in the meantime. And assessments of the level of the neutral likely level currently and going forward of the neutral Federal funds rate have changed, and are quite a bit lower than they stood in 2012 or earlier years. That means that the economy is, has the potential where policy could be constrained by the zero lower bound more frequently than at the time that we adopted our 2% objective. So it’s that recognition that causes people to think we might be better off with a higher inflation objective. That is an important set, this is one of our most critical decisions and one we are attentive to evidence and outside thinking. It’s one that we will be reconsidering at some future time. And it’s important for our decisions to be informed by a wide range of views and research, which is ongoing inside and outside the fed. But a reconsideration of that objective needs to take account not only of benefits of a higher potential benefits of a higher inflation target, but also the potential costs that could be associated with it. It needs to be a balanced assessment. But I would say that this is one of the most important questions facing monetary policy around the world in the future. And we very much look forward to seeing research by economists that will help inform our future decisions on this.”
To which former Minneapolis Fed President Narayana Kocherlakota, one of the signatories of the “Rethink 2%” letter, responded:
— NRKocherlakota (@kocherlakota009) June 14, 2017
That’s a big change of heart indeed, and one that could have significant long-term implications for Fed policy. A higher inflation target would mean the central bank can provide additional stimulus to the economy in a downturn, potentially helping to prevent slumps that are as deep as the Great Recession, which wiped out 9 million jobs and left financial and social scars many Americans are still nursing.