LITTLE ROCK, Ark. — The case for the Federal Open Market Committee's (FOMC) adopting a specific target for inflation is that it should help avoid future inflation and increase the effectiveness of monetary policy in times of low inflation.
That was a key message of William Poole, president of the Federal Reserve Bank of St. Louis, as he spoke to a Junior Achievement of Arkansas conference today.
The increase in policy effectiveness should arise from two consequences of a formal system of inflation targeting, said Poole. First, the market will likely hold inflation expectations more firmly. Second, and probably more important, is that the inflation-targeting framework provides a structure within which the FOMC can better explain its monetary policy actions and the policy risks it must face. Inflation targeting should increase accountability not so much by keeping score of target hits and misses but rather by encouraging a much deeper understanding of how monetary policy decisions are made.
Poole said that most current FOMC members would probably be pretty close together in stating an inflation goal. A benefit of greater formality in defining the inflation goal, he said, is that individual FOMC members would have a clearer idea as to what the inflation objective is.
As an example, Poole said, Ive often said my preferred target rate of inflation is zero, properly measured. That is, allowing as best we can for measurement bias, which might be around a half a percent per year for broad consumer price measures, I favor literally zero inflation. Given measurement bias in price indexes, I might state my goal as inflation between 0.5 and 1.5 percent as measured by the personal consumption expenditures (PCE) price index. Others prefer a somewhat higher rate of inflation, perhaps in the range of 1 to 2 percent as measured by the PCE. Still others might favor a different target range, with a different midpoint and/or a wider or narrower range. An agreed-upon objective is much more important than the small difference between my own preference and the range of objectives I believe are favored by others. If the FOMC decides to discuss inflation targeting, all dimensions of specifying a target will be considered carefully.
Poole said he disagrees with those who suggest that adopting a formal inflation objective will cause policymakers to become inflation nuttersthose aiming to stabilize inflation no matter what it costsand, somehow, limit the Fed's ability to pursue other policy objectives. They should examine actual experience, Poole said. Not only did the Fed's commitment to price stability not prevent it from engaging in countercyclical monetary policyit facilitated it. Such an aggressive countercyclical monetary policy as pursued starting in early 2001 would have been unthinkable were it not for the fact that the credibility established over the years since Paul Volcker dramatically altered the course of monetary policy in October 1979.
Poole said he believes that having a formal inflation objective will add to the Fed's credibility and, consequently, its ability to engage in countercyclical monetary policy. The reason is simple, he said. The more open and precise the Fed is about its long-run inflation objective, the more confident the public will be that the Fed will meet that objective. The objective, and the accompanying obligation to explain situations in which the objective is not achieved, should increase the Fed's credibility.
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