MNI INTERVIEW: Fed Should Restore Simple 2% Goal-Brunnermeier

The Federal Reserve should abandon its policy of targeting averaging inflation over some undefined period of time and restore a simpler 2% goal, Markus Brunnermeier, former adviser to the U.S. central bank and co-author of a new G30 paper, told MNI.

“Going back would be simpler,” said Brunnermeier, a Princeton University economics professor who has also worked with central banks in Germany and Japan.

Fed officials could also make it clear that the 2% target isn't subject to precise fine-tuning, which would help monetary policy from over-reacting to small deviations, he said.

“Don’t make huge commitments, just because inflation is 1.8 instead of two,” he said in an interview. “I’m not arguing particularly for a range, but not such a sharp ‘it has to be exactly 2.0,’ to be a little bit more relaxed on the cycle, that’s all.” (See MNI POLICY: Fed To Consider Shift To Inflation Target Band)

In a paper with three former central bank chiefs, Brunnermeier warns policymakers are limiting room for action with complicated messages. He also criticizes them for relying too heavily on models that suggested inflation would be transitory after Covid. While emerging-market central banks were nimble as inflation surged, advanced nations' monetary policy was hobbled by unrealized fear of Japan-style stagnation and vague commitments to keep stimulus in place, he said.

DATA DRIVEN, NOT AUTOPILOT

“We are against a data-driven policy that is really a hidden form of forward guidance,” Brunnermeier said. “You should not commit to some form of forward guidance and essentially tie your hands.”

The Fed is due to re-examine its goals in 2025 after adopting a flexible average inflation target in 2020 without laying out exactly what timeframe the average would be based on. Officials said the shift would counter a long period of below-target price gains, and the G30 paper suggested such preconceptions helped lead to a delayed response when the pandemic began lifting prices.

The lesson now isn't a swing to big rate cuts Brunnermeier said, noting the stubbornness of price gains seen in the 1970s. “The one big advantage this time around was that inflation was well anchored,” he said. “It’s very important to maintain this anchor and that also means if inflation comes down, you stay on the current projection for a while and only when it’s persistently down you can loosen again.”

The U.S. economy is still being powered by a strong job market and a fiscal deficit around 7% of GDP, he said, more reason for caution about monetary easing, he said. “The monetary side has to be more stepping on the brakes in order to make sure inflation stays down.”

KEEP SOME FLEXIBILITY

Central banks should also be attentive to massive balance sheets that risk "dominance" by politicians seeking help with debt costs, or from financial institutions seeking to avoid losses on weak investments, he said.

Some central banks compounded their problems by talking about a sequence of removing stimulus between raising interest rates and switching from QE to QT, he said. (See: MNI INTERVIEW: Fed Needs Better QE Guardrails- Fed Adviser)

“If you do unconventional monetary policies which tie you down, which trap you essentially into something, you cannot react and stabilize situations," he said. “Don’t be so bold that you say you can predict in the next two years what will happen and you can tie your hands. Keep some flexibility.”