Fed’s Pianalto Says Energy Cost May Call for Inflation Goal

Federal Reserve Bank of Cleveland President Sandra Pianalto said an explicit inflation target from the central bank may be warranted to ease concerns that inflation will become a problem.

“With the potential for inflation expectations to be more volatile in the face of energy and commodity price shocks, I think it could be an opportune time for the FOMC to be more specific and publicly announce an explicit numerical inflation objective,” Pianalto said today in a speech in Pittsburgh. The FOMC is the policy-making Federal Open Market Committee.

“Establishing an explicit inflation objective would clearly communicate our policy intentions and affirm our resolve to achieve price stability,” she said. “It would also help the public to better evaluate the effectiveness of our actions as events unfold,” Pianalto told the Pittsburgh Chapter of the Association for Corporate Growth.

Fed Chairman Ben S. Bernanke and other Fed officials have advocated adopting an explicit inflation target for the central bank to better communicate their goals to the public. Some officials such as former Fed Vice Chairman Donald Kohn were skeptical of an inflation target. Unlike many central banks that focus primarily on inflation, the Fed has a dual mandate to consider both unemployment and inflation.

Pianalto said she supported a 2 percent target for the inflation rate and did not think an employment target would be workable.

Oil Prices

Though the economy faces risks from rising oil prices, the sovereign debt crisis in Europe and the earthquake in Japan, Pianalto said the economy has grown “more resilient” to such shocks. She said she would support completing that Fed’s $600 billion program to buy Treasury securities to aid the recovery.

“If the outlook evolves as we are seeing it today, I personally believe we will complete that asset purchase,” Pianalto said in response to audience questions. “Whether more will be required after the completion in June will depend on how the economic outlook evolves,” she said.

Pianalto said the Cleveland Fed ran a simulation of what would happen in an adverse scenario where the spike in commodity prices was sustained. The scenario, which she described as “very unlikely,” saw oil rising to above $140 per barrel by next year and to $170 a barrel in 2013, pushing the retail price of gasoline above $5 a gallon.

Inflation Rate

Pianalto said that in this scenario the “overall inflation rate would temporarily rise by about a percentage point, and then gradually decline back to the underlying inflation trend,” and that the “sustained surge in energy and commodity prices would be expected to spill over to broader consumer prices, but the effects would be small and fairly gradual.”

“I remain committed to fulfilling both aspects of our dual mandate for price stability and maximum employment,” she said. “It would be unwise for the Federal Reserve to establish a corresponding numerical objective for unemployment. The long-run sustainable rate of unemployment can move around for a variety of reasons, such as the demographic makeup of the population and changes in how labor markets function.”

Pianalto said that the rise in oil prices is unlikely to spread to other prices. “The natural question in these times is whether these higher prices will be enough of a driving force to cause a lasting increase in the rate of inflation. At this point, I don’t think they will,” she said.

Oil Rises

Pianalto said she expects the “underlying trend in broad consumer prices, which is currently quite low, to rise only gradually toward 2 percent by 2013.”

Oil rose the most in two weeks today and was poised for its third quarterly gain in New York amid concern that the Libyan conflict will prolong production cuts.

Crude for May delivery surged $2.02, or 1.9 percent, to $106.29 a barrel at 9:31 a.m. on the New York Mercantile Exchange. Futures have increased 16 percent from January through March, the strongest first quarter gain since 2005.

The conflict in Africa’s third-largest producer is the bloodiest in a wave of uprisings that has toppled the leaders of Tunisia and Egypt and spread to Algeria, Bahrain, Iran, Oman, Syria and Yemen.

Pianalto said she expects the recovery to continue. “I still expect the economy to continue to expand at a moderate rate, a bit above the average growth rate of 3 percent per year,” she said.

“I fully support the FOMC’s most recent decision to continue our asset purchase program as originally scheduled, and its assessment that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” she said.

Pianalto, 56, became president of the Cleveland Fed in 2003. She is not a voting member of the FOMC this year and has never dissented from a FOMC decision. Fed presidents rotate voting on monetary policy, with Pianalto voting every other year.

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