BY R.A.
| LONDON
SOMEWHAT
surprisingly, inflation has been picking up in America in recent months. Not in
any worrying way; indeed, the Fed's preferred gauge of inflation, the price
index for personal consumption expenditures, remains below the 2% target, as it
has done for most of the last four years.
But the move upward since late 2015
is unmistakable, and amid what looks like the end (for now, at least) of a long
boom for the dollar and a long bust for oil prices, a rise in inflation to and
above 2% seems increasingly likely. Above-target inflation is an opportunity
for the Fed. It's not clear the central bank is prepared to seize it,
however.
At the press conference after
the March meeting, Janet Yellen, the Fed's chair, was asked how the committee
would deal with higher inflation. The response was not excessively clear:
So, I want to make clear that our
inflation objective is 2 percent and we're projecting a move back to 2 percent,
and we are not trying to engineer an overshoot of inflation, not to compensate
for past undershoots, so 2 percent is our objective. But it is a symmetric
objective, and we certainly don't seek to overshoot our objective. But some
undershoots and overshoots are part of how the economy operates and our
tolerance for those is symmetric with respect to under and overshoots.
The
popular interpretation of this statement, and the Fed's general approach, is
that the central bank does want to see inflation overshoot the target for a
while in order to reinforce that 2% is symmetric: undershoots matter as much as
overshoots. But it doesn't want to be seen as having pushed for or generated
the overshooting. Passive acceptance is ok; active inflation boosting,
apparently, is not. That would be fine if interest rates were not so close to
zero, but alas they are.
Ms Yellen and her colleagues would like to raise
interest rates by much more than they have managed to do so far. Low rates
threaten financial stability, they reckon, and they make it much more difficult
to respond to an economic downturn without turning to less-proven monetary
tools like negative interest rates or quantitative easing. But the Fed's quest
to boost rates keeps running into a problem. Financial markets are global.
Thanks to a glut of precautionary saving around the world and limited appetite
for investment, the global real interest rate appears to be stuck close to zero
(a phenomenon explained in more detail in this week's Free exchange column).
When a country like America moves to raise its
benchmark interest rate, and global markets anticipate returns on safer assets
above what they can get elsewhere in the world, capital floods into those safer
assets. The dollar rises, placing a drag on growth and inflation in America.
And the price of riskier assets falls, touching off a cycle of fear in markets
and threatening economic recovery around the world. This process has unfolded
each time the Fed has moved to tighten policy, most recently in the early weeks
of this year, and it tends to conclude with signals from the Fed that it will
slow the planned pace of tightening.
The Fed therefore faces some significant constraints
on its freedom to act. It isn't helpless, however. The Fed can raise the
interest rates it controls without raising the real, or inflation-adjusted, interest rate, if
expectations for future inflation are also rising. If you're planning on taking
out a loan for five years, then you care about the interest rate you're going
to pay, but you might also care about the rate of inflation (assuming it isn't
low enough to ignore). A moderate rate of inflation erodes the value of the
borrowed principal, in effect making the loan cheaper to repay—that is,
reducing the "real" interest rate. If the public expected medium-term
inflation of between 2% and 4%, then nominal interest rates (the ones you hear
quoted) could rise relatively high without pushing up the real cost of
borrowing.
But
raising inflation expectations isn't the easiest thing to do. Inflation has
been very low for a long time, and it has been trending downward for most of
the last generation. The Fed fairly has the reputation for extreme, if not
quite Bundesbank-level hawkishness. Given deep-rooted expectations for
inflation and a belief in the Fed's commitment to low inflation, it would take
a very long period of actual above-target inflation for people to begin to
revise their beliefs.
Expectations
adjustment would happen much faster, however, if the Fed simply explained what
it was doing and why. By playing coy about its (admittedly presumed) intentions
to let inflation rise and stay above target for a while, the Fed will undermine
the economic benefit of the inflation. The Fed's benchmark rate will not be
able to go up by very much because expectations will not have adjusted very
much.
Of
course, an unwillingness to own up to desiring more inflation might not be the
only reason, or even the main reason, that the Fed has kept its message on
overshooting muddied. It could also be the case that internal divisions prevent
the Fed from setting a course to overshoot for a while. It is much easier to
get disagreeing colleagues to sit on their hands meeting by meeting than to
agree to announce a plan for higher inflation.
No comments:
Post a Comment