A top Fed official says a policy shift once seen as radical is 'not nearly as scary as you might think'

  • John Williams, president of the Federal Reserve Bank of San Francisco, thinks the central bank needs new tools to fight chronically low inflation.
  • Williams, speaking at a Brookings Institution conference in Washington, made the case for a shift to a price-level target, which would have called for more aggressive interventions during the Great Recession.
  • Williams is worried the Fed has a “credibility problem” because it has fallen short of its 2% inflation target for much of the economic recovery.
  • Chronically low inflation points to a labour market that is still operating well below its full potential despite a 17-year low unemployment rate of 4.1%.

WASHINGTON – The Federal Reserve should consider moving away from targeting the inflation rate and instead target the overall level of prices, a move that would give the central bank greater room to stimulate the economy in the next recession, San Francisco Fed President John Williams said.

Top Fed officials have been worried for some time that a prolonged period of very low interest rates means the central bank will lack the power to address a future economic downturn, and this fear has in part driven the five interest rate increases implemented since December 2015, after the federal funds rate stood at effectively zero for seven full years.

Williams, speaking at a Brookings Institution conference entitled “Should the Fed stick with the 2% inflation target or rethink it,” made a clear case for the latter. He called for a system where the Fed would target the price level, meaning that it would compensate periods of undershooting the 2% inflation goal with periods of overshooting.

US inflation has remained chronically below the Fed’s 2% target for much of the economic recovery, suggesting the labour market is not as healthy as a 17-year low unemployment rate of 4.1% suggests.

Shifting to a price-level target is “not nearly as scary as you might think” Williams told the audience of monetary economists, academics, and market participants.

He also worried about “this issue of credibility” that has resulted from persistently below-target inflation, which makes it look “like the central bank is not committed to its goals.”

Prolonged low inflation, which also reflects soft wage growth, can make monetary policy less effective because “it gets into inflation expectations and makes it harder to achieve 2% objective in good times.”

In order for the change to work, however, it must be a committee decision that is rooted in some kind of long-run framework.

“There has to be a commitment to stay on that course for a number of years,” Williams said.

The chart below shows just how badly the Fed has fared as an inflation targeter. The Fed adopted an official inflation target in 2012.

InflationFederal Reserve Bank of Minneapolis

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