Bloomberg News

Plosser Says Fed Should Adopt 2% as Inflation Objective

November 15, 2011

(Updates with quote in sixth paragraph.)

Nov. 8 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank should adopt a 2 percent long-term inflation target to increase policy makers’ accountability and improve economic stability.

“Making such a clear and explicit statement should give the public confidence that the Fed’s commitment to its price stability mandate is a credible one,” Plosser said in the text of remarks given in Philadelphia today. “Being explicit about our inflation objective would help anchor expectations and reduce uncertainty about future policy steps.”

Policy makers last week affirmed their plan to reduce borrowing costs by lengthening the maturity of the Fed’s bond portfolio in a program known as Operation Twist. They also restated their commitment to keep the target federal funds rate near zero through at least mid-2013 as long as unemployment remains high and the inflation outlook remains “subdued.”

Fed Chairman Ben S. Bernanke said on Nov. 2 after the FOMC’s two-day meeting that the central bank may take new steps to boost growth, such as buying mortgage bonds or changing the way it communicates its policy goals to the public. Bernanke warned that economic improvement is likely to be “frustratingly slow,” with policy makers predicting a 1 percentage point drop in the jobless rate to about 8 percent over two years.

The central bank should “strengthen the framework for U.S. monetary policy through enhanced commitment, credibility, and communication and, in so doing, improve economic stability,” said Plosser, who has repeatedly called for the adoption of a numerical target for inflation since becoming the Philadelphia district bank chief in 2006.

Inflation Goal

In addition to specifying an inflation goal, the Fed should “provide more information about the expected path of policy” and “be more explicit” about what economic factors will influence monetary policy, Plosser said.

“If the Fed chooses a consistent set of variables and sticks to them, the public would better understand our reaction function and thus have a greater ability to form judgments about the likely course of policy,” Plosser said. “This approach would reduce uncertainty about policy actions and promote stability.”

After voting against the commitment to keep rates low until mid-2013 in August and Operation Twist in September, Plosser last week supported the Federal Open Market Committee’s decision to maintain the policies. Dallas Fed President Richard Fisher and Minneapolis Fed President Narayana Kocherlakota of Minneapolis also voted in favor of last week’s FOMC statement after dissenting against the decisions to ease at the prior two meetings.

Target Rate

Plosser said he dissented against the Fed’s commitment to keep its target rate near zero until mid-2013 because he was “concerned that this would be misinterpreted by the markets as suggesting that monetary policy was no longer contingent on how the economy evolved.”

The central bank’s use of the phrase “extended period” to convey the expected path of monetary policy is “vague” and also “not very satisfactory,” he said.

“I believe policy should always be a function of the state of the economy, rather than an ‘extended period’ or a specific calendar date,” the Philadelphia Fed chief said.

Plosser said he also opposes allowing the inflation rate to rise above 2 percent. The strategy would risk a repeat of the increase in inflation during the 1970s, when policy makers tolerated higher prices as they sought to create jobs.

Severe Recession

The plan “ultimately failed” and led to a “severe recession,” Plosser said.

In addition, using rising prices to “begin a process of inflating away many of the bad debts that people think are holding back economic recovery” is “poor monetary policy,” he said.

“It is probably poor fiscal policy too, but it would undoubtedly mix monetary policy and fiscal policy in a way that could undermine the independence of the central bank and its ability to maintain price stability,” he said.

The vote for last week’s statement was 9-1. Chicago Fed President Charles Evans opposed the decision, the first dissent in favor of easier policy since a vote cast by Boston Fed President Eric Rosengren in December 2007.

--Editors: James L Tyson, Carlos Torres

To contact the reporter on this story: Caroline Salas Gage in New York at csalas1@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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