A "Comfortable" Level of Inflation


For much of his nearly a quarter-century at the Federal Reserve, J. Alfred Broaddus had a reputation as a staunch inflation fighter. But when deflation began to threaten in wake of the 2001 recession, the Richmond Fed Bank president shifted his stance, arguing that the central bank needed to be as steadfast in resisting falling prices as it had been in containing rising ones.

Broaddus, who'll retire on Aug. 1 after turning 65, spoke about his latest thinking in an interview with BusinessWeek Senior Writer Rich Miller on June 7. Edited excerpts of their conversation follow:

Q: Is the recent rise in inflation a concern?

A: It wasn't very long ago that I thought there wasn't an inconsequential threat of deflation. I'm comforted now that this downside risk has gone away. In the 12 months ending in December, the core PCE [personal consumption expenditure] price index was up 0.8%. In March it was up 1.4%. That's a rate of inflation, if it were to stay in that range, that I would be comfortable with.

But obviously the inflation numbers have been moving up. We need to watch them carefully as we go forward to make sure we don't get behind the curve. I don't believe we're behind the curve. And at this point, job one is to make darn sure we don't get behind the curve.

Q: What drives inflation?

A: Unit-labor costs are a good indicator of the short-run factors affecting inflation. The latest numbers for the first quarter have shown an increase [in unit-labor costs]. It's certainly not a robust increase yet. But the risks on inflation are more balanced. We need to give more attention to the upside risks.

Q: In a recent speech, you said the inflation risks are manageable. Do you still think that?

A: That's still the way I feel about it. One of the underlying factors helping us to control inflation is the increased credibility of monetary policy. A good way to look at this is to compare the situation in 1994 with the present situation. We didn't have full credibility [as an inflation fighter] then. In that environment, when inflation expectations began to move, there was a risk that you would have a self-propelling, self-fulfilling dynamic.

Our performance since then and our greater credibility help to undercut that process. It doesn't remove the risk. It doesn't guarantee that inflation and inflation expectations won't rise. But it makes it a less volatile risk than it would be otherwise. It's not a reason for getting overconfident, not a reason for getting complacent. It's just a reason for taking, you might say, a measured approach.

Q: Some analysts peg the underlying trend growth rate of productivity at 2.5% to 3%. What do you think?

A: That's as good an estimate as any. Trying to predict the underlying trend growth in productivity is fraught with difficulty. We know that we've had a strong increase in the longer-run underlying trend growth in productivity. We know that that has been largely driven by IT [information-technology] innovation and other innovations, as these things are applied to business. That's very likely to continue. And that will help to restrain inflation.

Q: What's the long-run equilibrium level for unemployment?

A: I think 5% is a good number. It's possible it may be a little higher than that now. There's been a lot of turnover, people leaving jobs in manufacturing. They may not be prepared to take the new jobs being created [because they lack the skills]. I think there's slack in labor markets, but it's diminishing.


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