Former Federal Reserve Vice Chairman Donald Kohn said that while forces slowing inflation will begin to ease during the next few years, prices probably won’t begin to rise at the Fed’s preferred 2 percent rate for many years.
“The output gap will close slowly over the next few years” and “downward pressure” on inflation will “begin to abate,” Kohn said today at the University of Chicago Booth School of Business’s U.S. Monetary Policy Forum in New York. Inflation will “slowly move up” to the central bank’s desired level and it will “take several years to get there.”
The inflation gauge watched by the Fed, which excludes food and energy costs, increased 0.7 percent in the 12 months through December, the smallest advance since records began in 1959. Central bank officials prefer inflation ranging from 1.6 percent to 2 percent.
Kohn, 68, retired from the Fed in September and was a close ally of Chairman Ben S. Bernanke and his predecessor, Alan Greenspan.
The labor markets have been putting “downward pressure” on inflation and the financial markets don’t reflect the “degree of inflation worry” that some critics of the Fed’s policies have voiced, Kohn said.
The “huge increase” in commodity prices during the last six months is mainly a result of imbalances between supply and demand, Kohn said. Monetary policy has only played a “minor role,” he said.
U.S. budget shortfalls also feed inflation concerns and need to be addressed, Kohn said. “We would hear less about inflation risk” in the U.S. if our national debt was “on a more sustainable path,” he said.
When inflation eventually “threatens” the Fed’s goal of about 2 percent, the central bank will need to withdraw its record stimulus, Kohn said. The Fed will need to act “before inflation moves up in a major way,” he said.