The U.S. Federal Reserve adopted an inflation target in 2012. The Fed for a long time worried about price stability. Yet it took America’s central bank a couple of decades to catch up with what most of the rest of the world by adopting a firm target. Uniquely, the Fed also has a mandate to achieve “maximum” employment. Fed Chair Janet Yellen’s emphasis continues to be the latter—even though the U.S. unemployment rate is 4.9%, the lowest in eight years.
Little wonder then that there are doubts about whether the Fed really cares about hitting its bullseye of 2%. The central bank provided skeptics new talking points March 16 by opting to leave its benchmark rate unchanged at the ankle-high level of 0.25%. Narayana Kocherlakota, a former policy maker of recent vintage, accused his former colleagues of a lack of resolve. The economics team at RBC Capital Markets in New York said they were puzzled by much of what the Fed chief had to say on prices. “It seems Yellen is absolutely willing to let inflation run hot,” they said in a note for clients, even though she said the opposite when she met reporters after the decision.
It would be easier to build a case of wishy-washiness on inflation if these excellent critics agreed with each other. The RBC team, led by U.S. chief economist Tom Porcelli, thinks the Fed is ignoring clear evidence that price increases are about to burst a hole in the 2% ceiling. Kocherlakota thinks the Fed’s policy committee is negligent in its unwillingness to try harder to end lowflation.
Officials released quarterly economic projections with their interest-rate decision. The median estimate for growth in 2016 dropped to 2.2% from 2.4% in December, reflecting weaker global demand, the burden of a stronger dollar on exports, and increased market volatility. The outlook also includes each committee member’s outlook for inflation. These predictions assume that each central banker is king or queen and free to apply the measures he or she thinks necessary to meet the Fed’s targets. Kocherlakota noted that many Fed officials predict inflation of less than 2% two years from now, even in this hypothetical scenario. That, to him, signals a lack of ambition. “U.S. inflation has been below target for nearly four years,” Kocherlakota wrote. “This outcome is sometimes viewed as a sign of monetary policy impotence. But the Fed’s projections tell us that many, if not most, officials are actually aiming to keep inflation below target for an extended period of time. In other words, low inflation in the U.S. reflects a lack of will, not tools.”
Kocherlakota always was a bit of an outsider at the Fed. He started his career as a skeptic of aggressive monetary policy and then morphed into a vocal champion of quantitative easing. Kocherlakota continued to advocate for QE even after the majority at the Fed had decided to end the program. His willingness to change positions suggests a purity of heart. But it’s unclear if he is correct. Porcelli, who has had a good handle on the U.S. economy in recent years, sees inflation heating up. He cites several indicators, including U.S. “core” personal consumption expenditure (PCE), which already exceeds the Fed’s forecast for the end of the year. Core measures of inflation subtract volatile prices for food and energy and central bankers use them to get a clearer read on the future. PCE is the Fed’s preferred measure of inflation. Porcelli said it would take very little for core PCE to breach 2% within the foreseeable future.
If RBC is correct, then the Fed probably should have raised interest rates this week, or at least prepared investors to expect one sooner rather than later. But judging by surveys and asset prices, most market participants now think the Fed will do nothing before autumn. Yellen said this when asked about falling behind the curve: “Two percent is our objective, but it is a symmetric objective, and we certainly don’t seek to overshoot our objective.” She also said this: “Some undershoots and overshoots are part of how the economy operates.” And this: “We did take note in the statement of the fact that inflation has picked up in recent months. I see some of that as having to do with unusually high inflation readings in categories that tend to be quite volatile without very much significance for inflation over time. So I’m wary and haven’t yet concluded that we have seen any significant uptick that will be lasting in, for example, core inflation.”
Those could be the words of someone who is willing to let inflation run hot. Stock markets around the world had good days following the Fed announcement, suggesting a broad agreement that Yellen and her colleagues are more concerned with growth than inflation. But they could also could be the words of someone who still is waiting for a convincing narrative to emerge. Inflation can’t be too hot and too cold at the same time. Until the choice is clear, the Fed will continue to do what it did on March 16: Wait.
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