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Can a Federal Reserve chair make a promise today that binds their successor in the future?
That question is crucial as officials weigh how best to pursue their goals for maximum employment and stable prices. Minutes of their meeting last month -- released Wednesday in Washington -- showed policy makers are getting down to serious business.
Front and center in their review is what Chairman Jerome Powell calls makeup strategies for inflation -- promising to offset persistent undershooting of the Fed’s 2% target by allowing prices to run above that for a period of time, or vice versa.
One big problem with that: Powell may no longer head the central bank when it comes time to follow through on that vow.
Officials at the Sept. 17-18 Federal Open Market Committee meeting talked about two options -- surrounding the 2% inflation goal in a range, or trying to hit that number on average over time with so-called makeup strategies.
The minutes show that Fed staff used model simulations to show policy makers various properties of makeup strategies. The results were met with some skepticism.
“Many participants expressed reservations with the makeup strategies analyzed by the staff,” the Fed said. Some officials expressed concern that the framework would sacrifice too much of the central bank’s policy flexibility, and that “such commitments might be difficult for future policymakers to follow through on.”
On the other hand, there looked to be broad support for strategies that deliver inflation at their 2% target on average over time, with most participants open to the possibility that this was the best way to go.
In addition, several participants supported the idea of a target range for inflation, with a couple in favor of looking at policies where either the midpoint of the inflation target range is modestly above 2%, or where 2% acts as an inflation floor.
Both Vice Chairman Richard Clarida and New York Fed President John Williams have spoken about the strengths of catch-up strategies while acknowledging weaknesses. Average inflation targets could require a future chair to tighten policy after a period of overshooting 2%, even though the economy at that time might call for different policy action.
“I am nervous about it,” Richmond Fed President Thomas Barkin told reporters on Sept. 26 when asked about make-up strategies. “Trying to over-tinker in pursuit of a modest outcome is a difficult act to get right.”
Under its current approach, the Fed treats inflation misses as “bygones” and does not try to make up for them over time.
Several policy makers at the FOMC’s September meeting expressed concern with making promises about policy that future officials would be bound to. The staff analysis also emphasized that the benefits of such strategies would depend on the private sector’s understanding of them and how future policy makers might follow through on them.
“I don’t want to make commitments now to how we’ll act on inflation in the future,” Dallas Fed President Robert Kaplan told reporters on Oct. 3 in Houston.
“If we decided currently that we’ll run inflation a little hotter in this situation, or run the job market a little hotter, that’s a debate I’m very willing to have,” he added. “But I understand the facts of this situation. Where I struggle is starting to make commitments now on how we’re going to behave in a future situation when I don’t know the facts.”
The key issue confronting Fed officials is the likelihood that they will have to cut rates to zero again in the next recession.
Slower rates of trend growth in the U.S., and the Fed’s consistent undershooting of its 2% inflation goal since it was adopted in 2012, have kept interest rates unusually low. The U.S. economy is in its eleventh year of expansion -- the longest on record -- and the bottom of Fed’s policy rate range is just 1.75%. Government 10-year notes yield even less.
Fed officials describe their inflation goal as “symmetric,” meaning they want to lean against undershoots as much as overshoots. But their track record suggests they treat the target like a ceiling. Their preferred price index has only averaged 1.5% since the expansion began in mid-2009.
In the end, the policy review is about how to come up with a mechanism that changes the central bank’s behavior and consistently delivers 2% inflation over time. The minutes showed the committee is willing to take a first step and redefine the target as an average over time, which allow for some overshoots to compensate for undershoots.
“Most participants were open to the possibility that the dual-mandate objectives of maximum employment and stable prices could be best served by strategies that deliver inflation rates that over time are, on average, equal to the committee’s longer-run objective of 2%,” the minutes said.
(Updates with details of FOMC’s September meeting minutes throughout.)
--With assistance from Christopher Condon, Sophie Caronello and Rich Miller.
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