Wednesday, April 04, 2007

Fed ‘should seek 1.5% inflation rate’

Fed ‘should seek 1.5% inflation rate’
By Krishna Guha in Washington
Copyright The Financial Times Limited 2007
Published: April 2 2007 22:39 | Last updated: April 2 2007 22:39

The Federal Reserve should target an inflation rate of 1.5 per cent, Bill Poole, president of the St Louis Fed, said on Monday, joining a public debate that has exposed disagreement at the highest ranks of the US central bank as to what its ultimate inflation objective should be.

His comments in effect reject the suggestion by Frederic Mishkin, Fed governor, that it may not be worth trying to drive inflation below 2 per cent because of the likely cost in lost jobs and output.

Mr Poole painted an upbeat picture of the US economic outlook, while also hinting that the Fed has revised down its estimate of potential growth to below 3 per cent.

“Our economy is sound . . . Economic activity is growing at approximately the same rate as potential, despite the housing slowdown,” he said, adding: “Inflation is retreating as energy prices stabilise.”

He did not elaborate on what he thought the potential growth rate was. But with fourth-quarter growth at 2.5 per cent, his remarks most likely imply an estimate in the region of 2.7-2.9 per cent.

Mr Poole observed that the fourth-quarter growth figure understated the underlying trajectory of demand, with final sales growing at a “robust” 3.7 per cent.

The St Louis Fed president joined Michael Moskow, head of the Chicago Fed, in reaffirming his commitment to the “comfort zone” of 1-2 per cent inflation as measured by the core personal consumption expenditure deflator – a zone Mr Mishkin implicitly suggested was too low. Mr Poole restated this as an inflation objective of 1.5 per cent with a tolerance zone of 0.5 per cent on either side.

“I regard price stability as zero inflation,” he said.

This underscores the discomfort he feels with the present rate of inflation, and his determination to ensure it comes down as anticipated.

However, Mr Poole underlined that the choice of any particular inflation target was less important than Fed policymakers agreeing to unite around a single specified objective.

“Agreement on some reasonably low rate of inflation is more important than exactly what that rate is,” he said.

Mr Mishkin, a longtime champion of inflation targets, would certainly agree with that proposition, though Fed traditionalists such as Don Kohn, vice-chairman, might question whether stating the inflation objective would bring large benefits.

Mr Poole made it clear the Fed could not expect the public to have a full understanding of how Fed policy would operate in the future unless the bank itself agreed what its inflation objective was and laid out a coherent policy regime.


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