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Fed’s Inflation Goal May Raise Issues, Bini Smaghi Writes in FT

The Federal Reserve’s decision to set a numeric inflation goal over the longer run may raise communication issues, former European Central Bank Executive Board Member Lorenzo Bini Smaghi wrote in the Financial Times.

Monetary policy produces its effects with two or three-year lags, meaning a longer-term inflation objective makes the inflation forecasts and the policy decision “unclear,” as the long-run isn’t a “policy-relevant” time frame, Bini Smaghi wrote in an article posted on the newspaper’s website today.

The publication of the 17 Federal Open Market Committee members’ expectations of the Fed funds rate over the next few years may also raise “several questions,” he said. The market needs to know what forecasting model is used by FOMC members to update their interest-rate expectations, as they are conditional on the state of the U.S. economy, he wrote.

“The suspicion may arise that the interest rate forecasts are ultimately dictated by the members’ short-term policy preferences, rather than by their ability to predict prices over the long-term,” Bini Smaghi said.

The concept of a conditional interest-rate forecast may also not be understood by the public and politicians, which may lead to misunderstandings, the Italian economist wrote.

“To be effective, central bank communication needs to be well understood not only by sophisticated market participants but also by the public,” Bini Smaghi said. “As they are currently designed, the new tools might turn out to be too complex, and risk creating confusion, for both groups.”

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