US Federal Reserve Building in Washington
by Michael S. Derby
(Reuters) – Two U.S. central bank (Fed) officials recently said they were open to a revision to the U.S. central bank’s medium-term inflation target of around 2%, although the path to a debate or even a revision of that rate is strewn with pitfalls.
“Could we reconsider? Sure, but we can’t until inflation gets back to 2%,” Minneapolis Fed President Neel Kashkari said in an interview with Reuters on Monday.
Once the Fed gets inflation down to 2%, “then we could discuss what the right target should be,” he added.
In late April, Patrick Harker, the president of the Philadelphia Fed, also hinted that the 2% target could be revised at some point.
“We don’t want to change it now,” he added, but also hinted that might be the case in the future.
The target of a price change of around 2% was set in 2012, leading the Fed to officially conduct monetary policy based on this rate.
It would be difficult to change this target, as Fed officials have vigorously defended it since it was adopted.
During the press conference following the Fed’s monetary policy decisions on March 21 and 22, the President of the US Federal Reserve, Jerome Powell, spoke against a change in this target, stressing that the institution’s firm commitment in favor of this rate of 2% helped to strengthen confidence in price stability despite current inflationary pressures.
However, Jerome Powell himself has committed to a review of the Fed’s operating framework every five years, meaning that a review of the current inflation target could take place in 2025, after the 2020 review.
The 2% target is being debated as the median forecast by Fed officials in March has inflation still slightly above 2% by the end of 2025.
A BIG CHALLENGE
In the years following the adoption of the 2% target, inflation was consistently below this rate, leading some economists to support the idea that raising this ceiling would increase expectations of higher prices and would help bring real inflation closer at the desired threshold.
Today, with inflation remaining more than twice the target despite 14 months of sharp interest rate hikes, some observers believe that raising the target will reduce pressure on the Fed to maintain a restrictive monetary policy with the risk of significant damage to the labor market.
Many observers also believe that the most easily acceptable measures to curb inflation have come to an end, and that the final stages of reaching the 2% target risk leading to a veritable economic disaster.
“It will not be easy to reach the 2% target and it may be very difficult for the Fed to say ‘we have to reach the 2% target and we will keep interest rates very high.'”, warns Olivier Blanchard.
The former chief economist at the International Monetary Fund (IMF) and current researcher at the Peterson Institute for International Economics points in particular to possible collateral damage with the maintenance of such a target.
On Tuesday, Olivier Blanchard told a conference organized by the Brookings Institution, which advocates a 3% inflation target, that he expected a debate on the relevance of maintaining the 2% rate as soon as inflation approaches that threshold.
He added that the Fed could now be less aggressive in raising interest rates to reach its 2% target in light of the possible damage to the economy.
Ben Bernanke, the former head of the Fed, said he shared Olivier Blanchard’s point in “theory”. However, he noted that in practice no change would be possible without approval from the US Congress.
According to Ben Bernanke, an approach to US parliamentarians could lead to a goal that the Fed itself might not want.
“Given our current situation compared to the original position, making this change is a real challenge,” he concluded.
(Reporting by Michael S. Derby; French version by Claude Chendjou)