James Bullard, president and CEO of the Federal Reserve Bank of St. Louis, said today in an interview with Bloomberg that the Fed shouldn’t raise short-term interest rates if inflation is below 1.5%, and that a 1.5% inflation floor would “reassure markets” that have been swept up in turmoil as participants begin to anticipate a tightening of monetary policy.
Bullard also said that he would recommend increasing the size of the central bank’s quantitative easing program if inflation were to fall below 1%, a scenario he said would have him “pretty concerned.”
On Wednesday, the Fed shocked markets with its decision to refrain from announcing the first tapering of the pace of monthly bond purchases it makes under its quantitative easing program. A reduction of $US10-15 billion in the amount of purchases it makes each month was widely expected on Wall Street and among market participants.
The “inflation floor” Bullard mentioned today is an idea that has been gathering steam in economic and investment circles in recent weeks, and his comments on the subject led Owen Callan, a fixed income dealer at Danske Bank Markets, to quip in a tweet that perhaps we’ve just seen the introduction of the “Bullard Rule.”
The Fed currently offers forward guidance on the future path of its main policy rate based on the “Evans Rule,” named for Chicago Fed president Charles Evans.
The rule, adopted by the Fed at the conclusion of its December 2012 meeting, dictates that the Fed won’t consider raising short-term rates “at least as long as the unemployment rate remains above 6-1/2 per cent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 per cent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
JPMorgan economist Michael Feroli explained the rationale behind tweaking the Fed’s current forward guidance by adding a floor for inflation — e.g., the Bullard Rule — in a recent note to clients, saying that “given the existing 2.5% upper bound on an acceptable inflation outlook, adding a 1.5% lower bound would serve to emphasise the symmetry around the Fed’s longer-run inflation goal.”
“Stating that the Fed won’t raise rates if the inflation outlook one to two years ahead is below 1.5% wouldn’t really convey much new information: even without such a statement it’s likely that few now believe a reasonable committee would tighten with such an outlook,” said Feroli. “Because of this, an inflation lower bound probably wouldn’t face too much resistance in the committee. Indeed, the July minutes’ reference to this option mentioned only positives, but no drawbacks. For this reason we see an inflation lower bound as a relatively cheap option to send a modestly dovish message, albeit an option that probably wouldn’t do much to change policy expectations.”
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