In an era when deflation concerns are just as valid as hyper inflation worries, Federal Reserve officials have been discussing whether the central bank should adopt an inflation target to anchor price expectations. Many analysts believe it will be a primary topic in the two-day monetary policy meeting beginning Tuesday.
Officially adopting an inflation target would probably require the approval of Congress, which means the chances that the Fed announces such a tactic in this week's monetary policy statement are slim, but it remains a possibility in the near future.
Elsa Dargent, economic researcher at Natixis, said the Fed's main concern for price stability is deflation, as falling commodity prices have sent producer and consumer prices into a downward spiral. Some board members may believe setting a numerical target will build the Fed's credibility, she added.
"I think there have been debates, but no consensus was seen in the minutes," she said of the Dec. 16 meeting, when the issue was a hot topic. "We'll have to look closer in the statement (this) week."
Rudy Narvas, macroeconomist at 4Cast, pointed out that with New York Fed president Timothy Geithner now taking the helm at the Treasury, the Fed will have "an important ally" if they decide to move forward with the idea.
As for whether a target is actually a good choice, Narvas called it a "very important" tool to "anchor expectations, with respect to wages and business decisions."
It is unclear whether the Fed would adopt an explicit numerical target, such as 2.0%, or a band akin to Canada's 1% to 3% objective. Narvas said Fed research points towards an explicit percentage target.
Last April, then-Fed Governor Frederic Mishkin said Canada's experience with a target band had been successful in building public trust and ensuring accountability. For the U.S., however, he advocated a specific numerical target because, he argued, the increased clarity offers greater flexibility for central banks to respond decisively to adverse demand shocks.
More recently, on Jan. 14, Philadelphia Fed President Charles Plosser said a numerical target would signal the central bank's commitment to maintaining price stability. A target would "not only help prevent inflation expectations from rising to undesirable levels, but it can also help prevent expectations from falling to undesirable levels," he said.
A day later, Chicago Fed President Charles Evans, a usually dovish official who sits on the Fed's voting board this year, said an inflation target would provide a pillar of support in the midst of "enormous uncertainty" in the economic climate.
Fed Chairman Ben Bernanke hasn't spoken on the topic recently, but his views on targeting inflation are well known from his writings published before he entered public life.
Bernanke literally co-wrote the textbook for setting a numerical target and co-edited an international case study. When he entered office in January 2006 - months before the crisis erupted - many believed adopting an inflation target would be his legacy at the Fed.
Whether Bernanke will lead a discussion of inflation targeting at the Fed's Open Market Committee (FOMC) on Tuesday and Wednesday remains to be seen. As for Canada, Bank of Canada Governor Mark Carney will deliver a speech entitled 'Inflation Targeting in a Global Recession' on Tuesday morning.
By Patrick McGee and edited by Nancy Girgis
©CEP News Ltd. 2009