The problem the Federal Reserve needs to solve these days is the risk of inflation that is persistently too low, rather than too high, a key central bank official said on Friday in discussing why it’s undergoing a strategic review.
New York Fed President John Williams said that the Fed’s current framework — aiming to keep inflation close to a 2% annual rate — faces significant challenges given the current global economic environment. That’s why the Fed has decided to review how it conducts interest rate policy, he added.
In his remarks, the New York Fed president did not discuss the immediate outlook for the economy or interest-rate policy.
Earlier this month, the Fed announced it will conduct a year-long review of its monetary policy tools and the way it communicates decisions in 2019. As part of that effort, the central bank will sponsor a research conference in early June in Chicago to get advice from outside experts.
Williams said the review was sparked by a shift in the global economy’s “neutral” interest rate.
In the developed economies, aging populations, slower productivity growth and higher demand for safe assets has pushed down the so-called neutral interest rate that keeps the economy growing without sparking inflation, Williams said.
With the Fed aiming for a 2% inflation target, the result of a low neutral rate is that sometimes inflation will stay below 2%. The market will come to expect low inflation and this can make the economy suffer more in a downturn.
Williams said the first option is “to maintain the basic framework of inflation targeting and to rely on a combination of aggressive conventional and unconventional policy actions when facing economic downturns to limit the deleterious effects of the lower bound.”
Williams said the Fed has to consider as part of its review switching to an “average-inflation targeting” where the central bank would target above-target inflation rate in “good” times. This can keep inflation expectations in line with the target.
A third option is price-level targeting, where the Fed commits to keep the price level on a steady growth path, he said.
“Although price-level targeting is a bigger leap from inflation targeting than average-inflation targeting, each can be implemented in ways that are very similar to standard inflation targeting, either in terms of forecast-targeting or a policy rule,” Williams said.
Greg Robb is a senior reporter for MarketWatch in Washington. Follow him on Twitter @grobb2000.
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