MNI EXCLUSIVE: Credibility To Help Fed Hit Price Goal: Staff

The Federal Reserve should manage to reach and maintain its longer-run 2% inflation target as the Covid-19 pandemic passes, because markets and the public trust policy makers' commitment to get there, two Kansas City Fed economists told MNI.

The Fed's 2% inflation target enshrined in 2012 kept expectations especially well anchored and that record should carry over to the averaging framework adopted earlier this year, the economists Brent Bundick and Andrew Lee Smith said in an interview.

"There's nothing in our work that says the Fed can't achieve its target," Bundick said. "The Fed has built up a [considerable] amount of credibility over time."

Chair Jerome Powell has said the Fed will do whatever it takes to right the economy again and the FOMC's forecasts shows policy makers expect to hold interest rates near zero for several years.

The economists emphasized that the Fed's 2% goal is a long-run target, and that the current environment remains far from normal as the Covid pandemic continues.

While the FOMC's exact definition of longer-run is unclear, Bundick and Smith said, "it's not too surprising that in 2023, just three years from now, the median [Fed] projection doesn't show inflation cresting above 2% given the historically deep contraction that the economy has just suffered."

Inflation was already below target even before the pandemic drove down prices as the health warnings emptied restaurants, stores and airline flights. Fed officials were puzzled by weak inflation in the last economic expansion, especially after unemployment dipped to a half-century low of 3.5%. Fed officials have said the new framework will help combat expectations of prolonged weakness.

FORWARD GUIDANCE AS STIMULUS

Bundick and Smith co-authored two recent papers, "The Dynamic Effects of Forward Guidance Shocks," and "Did the Federal Reserve Break the Phillips Curve," exploring these issues.

"Over the medium run, many non-monetary factors can sway inflation so it makes sense that the FOMC has continued to emphasize the long-run nature of its objective and its desire to anchor longer-run inflation expectations," Bundick told MNI.

The Fed announced in late August, after an 18-month review, that it was moving to an average inflation targeting framework that would also take into consideration a broader array of factors in assessing full employment.

Then at its September meeting the Fed unveiled new forward guidance indicating the central bank would be more cautious about raising interest rates in the future in the absence of sustained 2% inflation.

Research on forward guidance has found that "when you have announcements that either lower than path of expected interest rates or lower the uncertainty around that path--that can lead to lower long-term interest rates," Bundick said.