Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank should adopt a 2 percent long-term inflation target to increase policy makers’ accountability and improve economic stability.
“Making such a clear and explicit statement should give the public confidence that the Fed’s commitment to its price stability mandate is a credible one,” Plosser said in a speech in Philadelphia today. “Being explicit about our inflation objective would help anchor expectations and reduce uncertainty about future policy steps.”
Policy makers last week affirmed their plan to reduce borrowing costs by lengthening the maturity of the Fed’s bond portfolio in a program known as Operation Twist. They also restated their commitment to keep the target federal funds rate near zero through at least mid-2013 as long as unemployment remains high and the inflation outlook remains “subdued.”
Fed Chairman Ben S. Bernanke said on Nov. 2 after the Federal Open Market Committee’s two-day meeting that the central bank may take new steps to boost growth, such as buying mortgage bonds or changing the way it communicates its policy goals to the public. Bernanke warned that economic improvement is likely to be “frustratingly slow,” with policy makers predicting a 1 percentage point drop in the jobless rate to about 8 percent over two years.
Plosser said in response to questions from reporters after his speech that he doesn’t see further monetary easing as “justified” because the U.S. economy is returning to its “moderate growth” path. “Right now, I don’t see any necessity for further action,” said Plosser, who predicted growth of 2.5 percent in the second half of this year and 3 percent in 2012.
After voting against the commitment to keep rates low until mid-2013 in August and Operation Twist in September, Plosser last week supported the FOMC’s decision to maintain the policies. Dallas Fed President Richard Fisher and Minneapolis Fed President Narayana Kocherlakota of Minneapolis also voted in favor of last week’s FOMC statement after dissenting against the decisions to ease at the prior two meetings.
Plosser said that his vote in support of the November decision doesn’t represent a change in his views, and reflects a similar approach to the one he took at the beginning of the year when he rotated into a voting position. While Plosser opposed the Fed’s second round of asset purchases that began in November 2010, he didn’t dissent against policy makers’ decision to continue them in January as they were already under way.
Plosser said he’s “on record” with opposing the August and September decisions and doesn’t see the point in “re-litigating” the policies at every meeting.
U.S. stocks rose, erasing earlier losses, as Italian Prime Minister Silvio Berlusconi’s plan to resign bolstered optimism a new leader will be able to tame the nation’s debt crisis. The Standard & Poor’s 500 Index climbed 1.2 percent to 1,275.92 after slipping as much as 0.5 percent earlier. Treasuries reversed gains, with yields on the 10-year note climbing about 4 basis points to 2.08 percent at 4:10 p.m. in New York.
The central bank should “strengthen the framework for U.S. monetary policy through enhanced commitment, credibility, and communication and, in so doing, improve economic stability,” said Plosser, who has repeatedly called for the adoption of a numerical target for inflation since becoming the Philadelphia district bank chief in 2006.
In addition to specifying an inflation goal, the Fed should “provide more information about the expected path of policy” and “be more explicit” about what economic factors will influence monetary policy, Plosser said.
“If the Fed chooses a consistent set of variables and sticks to them, the public would better understand our reaction function and thus have a greater ability to form judgments about the likely course of policy,” Plosser said. “This approach would reduce uncertainty about policy actions and promote stability.”
Kocherlakota said the central bank should develop and make public a contingency plan that would explain how it would react to changes in the economy. The plan would “provide clear guidance on how it will respond to a variety of relevant scenarios,” reducing uncertainty about the Fed’s actions among consumers and companies, which he said has reduced incentives to spend and hire, he said.
Plosser said he dissented against the Fed’s commitment to keep its target rate near zero until mid-2013 because he was “concerned that this would be misinterpreted by the markets as suggesting that monetary policy was no longer contingent on how the economy evolved.” He also said he opposed the statement because he sees the “appropriate” policy path as requiring an increase in interest rates before then.
The central bank’s use of the phrase “extended period” to convey the expected path of monetary policy is “vague” and also “not very satisfactory,” he said.
“I believe policy should always be a function of the state of the economy, rather than an ‘extended period’ or a specific calendar date,” the Philadelphia Fed chief said.
Plosser said he also opposes allowing the inflation rate to rise above 2 percent. The strategy would risk a repeat of the increase in inflation during the 1970s, when policy makers tolerated higher prices as they sought to create jobs.
The plan “ultimately failed” and led to a “severe recession,” Plosser said.
In addition, using rising prices to “begin a process of inflating away many of the bad debts that people think are holding back economic recovery” is “poor monetary policy,” he said.
‘Poor Fiscal Policy’
“It is probably poor fiscal policy too, but it would undoubtedly mix monetary policy and fiscal policy in a way that could undermine the independence of the central bank and its ability to maintain price stability,” he said.
The vote for last week’s statement was 9-1. Chicago Fed President Charles Evans opposed the decision, the first dissent in favor of easier policy since a vote cast by Boston Fed President Eric Rosengren in December 2007.
Fed governors and regional presidents cut their forecasts for growth, projecting that gross domestic product, adjusted for inflation, will rise by 2.5 percent to 2.9 percent next year. In June, they forecast a range of 3.3 percent to 3.7 percent. Growth in 2013 will be 3 percent to 3.5 percent, lower than the prior range of 3.5 percent to 4.2 percent, based on the median range of forecasts.
“A lot” of the marking down in forecasts occurred in August, Plosser said. “It wasn’t new news.”
The U.S. jobless rate unexpectedly fell in October while employers added fewer workers than forecast. The unemployment rate declined to a six-month low of 9 percent from 9.1 percent, even as the labor force grew. The 80,000 increase in payrolls followed gains in the prior two months that were revised up by 102,000, Labor Department figures showed last week in Washington.
Plosser predicted that the unemployment rate will fall to the “low eights” percent next year and “mid sevens” percent in 2013. The recovery is returning to a “slow, modest slog,” he said.