MNI POLICY: Fed Conference Paper Favors Average Infl Targeting

By Jean Yung

     WASHINGTON (MNI) - Average-inflation targeting has some advantages over

price-level targeting, but Federal Reserve credibility is key for making any

inflation make-up strategy work, according to a study to be presented to the

Federal Open Market Committee on Wednesday as it prepares to review its policy

framework.

     Lars Svensson of the Stockholm School of Economics argues that inflation

make-up strategies have some desirable "automatic stabilization" properties. An

inflation shortfall will raise inflation expectations, lower the real interest

rate and provide stimulus to the economy, and help move inflation back toward

the target.

     Average-inflation targeting also allows for flexibility. If it's

successful, the averaging period can be extended so that it works almost like

price-level targeting. If less successful, average-inflation targeting allows

for a retreat to annual-inflation targeting.

     And in contrast to temporary price-level targeting, which only kicks in

when rates hit zero, average inflation targeting would operate all the time,

making it more likely to be understood and credible.

     Credibility is key, Svensson wrote. The strategy would only work if the

private sector believes that the central bank will deliver and make up according

to the strategy. "This probably requires that economic agents need to see the

policy practiced and its principles obeyed, in order to believe that it will be

maintained and be successful in the future."

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

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