LOGAN, Utah – Federal Reserve Bank of St. Louis President James Bullard delivered remarks titled “Hawks, Doves, Bubbles and Inflation Targets” on Monday during the 2012 George S. Eccles Distinguished Lecture at Utah State University’s Jon M. Huntsman School of Business.
Bullard discussed the Federal Open Market Committee’s (FOMC’s) decision at the January 2012 meeting to name an explicit, numerical inflation target of 2 percent. While some discussion has suggested that inflation targeting is inconsistent with the Fed’s dual mandate to promote maximum employment and stable prices, Bullard said that “inflation targeting is perfectly consistent with the Fed’s dual mandate.” He added that “much of the discussion about the dual mandate is, in my view, really about the nature of the Fed’s reaction function to economic events,” which is separate from setting an inflation target. In addition, “inflation targeting is consistent with hawks, doves and even bubbles,” he said.
Bullard noted that with this move at the January 2012 FOMC meeting, the Fed joins many other central banks around the world in adopting an inflation target. The European Central Bank, for example, has an inflation target along with a single mandate to promote stable prices, which is in contrast with the Fed’s dual mandate. However, Bullard said, “in practice, monetary policy is viewed in the same way in Europe as it is in the U.S., despite the differing mandates.”
Bullard said that historically, central banks did not say explicitly what rate of inflation they were trying to achieve in the medium to long run, but this practice was called into question after the global inflation debacle during the 1970s. “Since the central bank controls the inflation rate, there seems to be little to be gained from ‘hiding’ the inflation target,” he said, adding that financial markets will “pencil in” their own perception of the inflation target, with some uncertainty about its true value. “That just adds unnecessary uncertainty to the macroeconomic system,” he said.
“Naming an explicit numerical inflation target is neither hawkish nor dovish,” Bullard said. “It is simply a recognition that the central bank controls the medium- to long-run rate of inflation, and that in order to minimize uncertainty the central bank may as well say what it is trying to achieve,” he stated.
Consistency with the Dual Mandate
Bullard discussed a simple economic model, in which the monetary authority controls a short-term nominal interest rate and uses a Taylor-type policy rule to describe the interest rate decisions. He said that in the model, the central bank can move the nominal interest rate to offset incoming shocks exactly, and inflation remains at the target rate and employment remains at the maximum level. Thus, he said, “the dual mandate is achieved exactly at every point in time.” With a single price stability mandate system, Bullard said that the essential story would not change and that “achieving the single mandate is still consistent with the maximum level of employment of households.”
Hawks and Doves
While inflation targeting is consistent with the dual mandate, Bullard noted that “there are more aspects to policy than just the inflation target.” He said that the Taylor-type policy rule partly depends on how aggressively the central bank reacts to inflation and to the output gap (which, in the model, is not the output gap of common parlance) when setting the nominal interest rate. Placing more weight on inflation might be viewed as “hawkish,” while placing more weight on the output gap might be viewed as “dovish,” he stated, adding that in both cases, the system operates within the context of an inflation target. “In other words, the nature of the policy rule is separate from the issue of naming an inflation target,” he said.
“I think most of the discussion about the dual mandate is really a discussion about how much emphasis should be put on each of the two parts of the Taylor-type policy rule,” Bullard added.
Beyond Interest Rate Adjustment
“Heavy focus on the nature of the Fed’s interest rate reaction function in the current environment is questionable,” Bullard said. “There are many issues at least as important, and resolution of any of those issues could change the argument for a particular reaction function.”
For instance, most monetary policy is not currently about interest rate adjustment, he said, adding that so-called “unconventional” policy (e.g., quantitative easing) has come to the fore. In addition, he noted that there has been discussion concerning the possibility that current Fed policy may lead to “bubbles” in the economy. This can occur if the weights on inflation and the output gap in the policy rule are too small, he said. “In effect, the policymaker must be sufficiently aggressive in responding to shocks,” Bullard said. One of the worst policies in this particular model is to place zero weight on both inflation and the output gap, which is also known as the “interest rate peg” policy because interest rates never change, he added. Actual policy rates in the U.S. have been near zero since December 2008 and are projected to remain there until late 2014, which Bullard said could be viewed as an approximation to the “interest rate peg” policy.