MNI POLICY: SF Fed Paper: Inflation Down to 1.7% in Good Times

--New Ideas Needed to Avoid ZLB, Revive Inflation Expectations

By Greg Quinn

     (MNI) - U.S. inflation will tend to be limited to about 1.7% even in

today's good times in part because investors think interest rates will get stuck

around zero in the next downturn, and policymakers may need new ideas to avoid

that trap, San Francisco Fed researchers said Monday.

     The risk of hitting the "effective lower bound" on rates can lower the

compensation investors demand to guard against inflation by as much as 80bps,

they said in a paper. 

     "More muted inflation expectations translate into weaker inflation, even

during normal times when the economy is doing well, as is currently the case,"

according to Robert Amano, Thomas J. Carter, and Sylvain Leduc. "Because of

lower inflation expectations, our model suggests that inflation should hover

around 1.7% during good economic times."

     Inflation and interest rates worldwide have waned in recent years because

of aging populations and an increase in global savings, they wrote. Doubts about

central bank firepower are adding to the drop in expected inflation. U.S.

inflation has remained below the Fed's 2% goal for most of the past 10 years,

averaging about 1.5% per year since 2010.

     "These findings suggest that the puzzle of how to raise inflation to meet

central bank goals may require new ways of addressing the risk of returning to

the ELB and new ways of understanding how to set and meet inflation goals," the

paper found. "According to the simulations, concerns that the central bank may

run out of ammunition during future recessions lead households to save more and

consume less, while businesses set lower prices. Both precautionary behaviors

weaken inflation expectations, even during expansions when interest rates are

above the ELB, as is currently the case."

--MNI Ottawa Bureau; +1 613-314-9647; email: greg.quinn@marketnews.com

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