One Federal Reserve president thinks the Fed is taking “unacceptable” risks.
On Wednesday, the Federal Reserve released its latest monetary policy decision, and perhaps the most notable element was the three dissents among the ten voting FOMC members.
On Friday, one of these dissenters, Minneapolis Fed president Narayana Kocherlakota issued an explanation of his dissent, writing that the Fed is taking “unacceptable” inflation risks and should be willing to bring back QE if inflation continues running below the Fed’s 2% target.
Kocherlakota wrote, “I dissented from the decision at the Federal Open Market Committee meeting earlier this week. After that meeting, the FOMC communicated its intention to continue gradually removing accommodation. In my view, this communication creates an unacceptable downside risk to inflation and inflation expectations.”
Kocherlakota added that, “The FOMC should also make clear that, if this forward guidance were to prove inadequate, it would be willing to use additional tools, such as asset purchases, to bring inflation back to its target.”
Kocherlakota is seen as the most “dovish” member of FOMC, or the member most in favour of the Fed keeping monetary policy accommodative.
Inflation data on Wednesday morning showed that headline CPI, which includes the cost of food and energy, fell 0.3% in November as gas prices tumbled 6.6%.
In her press conference on Wednesday, Fed Chair Janet Yellen said the effects of lower gas prices on inflation were likely to be “transitory,” and also said that if labour market conditions improve, current levels of inflation would be acceptable for the Fed to begin the process of raising interest rates.
Earlier this month, Kocherlakota said he would step down from his post when his term expires in 2016, and Wednesday was the last meeting that Kocherlakota, however, served as a voting member of the FOMC.
On Wednesday, Noah Smith had a great story on Kocherlakota over at Bloomberg View, outlining the ideological shift that Kocherlakota has undergone since joining the Minneapolis Fed. Back in 2009, Kocherlakota was seen as one of the most hawkish members of the Fed, but will exit as — by far — the biggest dove among Fed governors.
And he is not going quietly.
Here is Kocherlakota’s full note:
I dissented from the decision at the Federal Open Market Committee meeting earlier this week. After that meeting, the FOMC communicated its intention to continue gradually removing accommodation. In my view, this communication creates an unacceptable downside risk to inflation and inflation expectations.
Three key facts led to my decision.
- Past inflation: Year-over-year inflation has run below the FOMC’s 2 per cent target for over 30 months.
- Medium-term future inflation: The minutes of the FOMC’s October meeting state that the FOMC’s staff projects that inflation will remain below target over the next few years.
- Longer-term expected inflation: From November 2010 through July 2014 — 31 consecutive meetings — the FOMC was in a position to state that longer-term inflation expectations remain stable. Because of the decline in market-based measures of longer-term inflation expectations in the past few months, the Committee has not been able to make this assertion in the past three FOMC statements.
Despite these facts, the FOMC communicated its intention after this week’s meeting to continue gradually removing monetary accommodation. In my assessment, the FOMC’s failure to respond to weak inflation runs the risk of creating a harmful downward slide in inflation and longer-term inflation expectations of the kind that we have seen in Japan and Europe. I see this risk to the credibility of the inflation target as unacceptable, given how hard it would be for the FOMC to respond successfully if this eventuality did indeed materialise.
I would have preferred for the FOMC to communicate that it will keep the target range for the fed funds rate unchanged as long as the one-to-two-year-ahead outlook for the inflation rate remains below its target of 2 per cent. The FOMC should also make clear that, if this forward guidance were to prove inadequate, it would be willing to use additional tools, such as asset purchases, to bring inflation back to its target.
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