MNI EXCLUSIVE:Fed Inflation Overshoot Parameters Will Be Vague

--Fed To Adopt Average Inflation Targeting

--But Will Not Set Explicit Parameters For Overshoots

By Jean Yung, Pedro Nicolaci da Costa and Evan Ryser

     WASHINGTON (MNI) - The Federal Reserve is set to adopt a new framework

under which it would purposely exceed its 2% inflation objective to compensate

for extended periods of zero rates and very subdued prices, but will refrain

from setting specific parameters for how big an overshoot it would permit or for

how long, former senior Fed officials told MNI.

     The regime shift and culmination of a months-long policy framework review,

which ex-officials expect to come in September, will also lay the groundwork for

the Fed to set specific conditions under which it will maintain current

near-zero rates and QE. That latter decision could be made in a subsequent FOMC

meeting later this year, some sources said, although others thought it could

also be announced in September.

     "The Fed will simply say that its objective is for inflation to average 2%

over the medium term, but there won't be a lot of apparatus attached such as how

quickly deviations will be made up, how many years are in the reference window

for calculating average inflation, etc.," said Nathan Sheets, a former top Fed

and Treasury official.

     Policymakers are reluctant to tie themselves to any rigid formula for

average inflation, sources said.

     "This lite form of average-inflation targeting will go a long way toward

communicating the symmetry of the inflation target, while still giving them

flexibility to formulate appropriate policy from meeting to meeting."

     --FORWARD GUIDANCE

     Given that inflation has been below target for some time, forward guidance

to keep the policy rate at zero until inflation has overshot 2% for a time would

also be consistent with hitting an objective focused on average inflation.

     "In the past, policy had begun to tighten well before you got to your

inflation objective. Now they recognize there are lags in monetary policy but

they would be quite comfortable if some overshoot occurs -- and that would be

desirable and would be tolerated," said former senior Fed economist Peter Hooper

now at Deutsche Bank.

     By contrast, "The Fed's current objective is to achieve 2%, and they would

not want to tolerate a sustained overshoot for any lengthy period of time, just

as they're uncomfortable with a sustained undershoot for any amount of time."

     --NOT YET READY FOR YCC

     A lack of consensus on whether caps on the short end of the yield curve

would help reinforce the credibility of forward guidance is likely an indication

that some framework issues are still under debate, former officials said.

     In addition to the inflation make-up strategy, the FOMC is also expected to

codify in its one-page longer-run strategy statement that forward guidance and

asset purchases are its primary policy tools if rates are stuck at zero.

     Sources said this and other alterations to the Fed's policy framework would

likely be unveiled at the September 15-16 FOMC meeting and require careful

explanation by Fed Chair Jay Powell.

     Currently the statement reads: "The Committee reaffirms its judgment that

inflation at the rate of 2 percent, as measured by the annual change in the

price index for personal consumption expenditures, is most consistent over the

longer run with the Federal Reserve's statutory mandate.

     "The Committee would be concerned if inflation were running persistently

above or below this objective. Communicating this symmetric inflation goal

clearly to the public helps keep longer-term inflation expectations firmly

anchored."

     --COMMUNICATIONS

     The new inflation-targeting strategy will also likely be accompanied by

changes in how the Fed communicates its policy intentions via its statement and

dot plot, ex-officials said.

     Policymakers have considered numbering the dots in such a way that the

forecasts for the fed funds rate could be matched to projections for

unemployment, inflation and GDP over the medium term.

     The dots would still be anonymous.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

--MNI Washington Bureau; +1 202 371 2121; email: pedro.dacosta@marketnews.com

--MNI Washington Bureau; +1 202 371 2121; email: evan.ryser@marketnews.com

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