Fed Resists IMF Call to Allow Some Overshoot of Inflation Goal

  • IMF urges Fed to be wary of slowing inflation, policy reversal
  • Central bank feared disruptive effect of overshooting target

Inside the IMF's Checkup of the U.S. Economy

The Federal Reserve resisted a recommendation by the International Monetary Fund that the central bank be willing to let inflation modestly exceed its target, saying such a move could be counterproductive to its objectives, an IMF report showed.

The IMF last month recommended the Fed accept “some modest, temporary overshooting” of its 2 percent inflation target, given the risk that price increases will slow and the central bank may have to reverse course after raising its benchmark rate in December for the first time since 2006. The IMF made the call in a June 22 statement following the fund’s annual review of the world’s biggest economy.

The full version of the staff report released Tuesday revealed that U.S. authorities have “no intention to engineer an overshoot” and said the case for doing so wasn’t compelling. The Fed’s view also got support from “many directors” on the IMF’s board representing member countries, who “were concerned over the risks of de-anchoring inflation expectations and eroding monetary policy credibility.”

“Aiming to overshoot the medium-term target would create the risk of being behind the curve and potentially being faced with a need to raise rates more quickly especially if the labor market tightening led to a faster increase in inflation than seen until now,” according to the IMF report, which attributed the comments to U.S. officials. “This could be disruptive and undermine the achievement of the Federal Reserve’s mandates of maximum employment and stable prices.”

While the report, dated June 24, doesn’t specify if the U.S. officials were from the Fed or Treasury Department, IMF official Nigel Chalk told reporters on a conference call that monetary policy comments typically come from the central bank. As part of the fund’s consultations with the U.S., IMF Managing Director Christine Lagarde met with Fed Chair Janet Yellen and Treasury Secretary Jacob J. Lew in late-June, the report said.

Fed’s Thinking

“If incoming data shows economic growth continuing to pick up, labor market conditions continuing to strengthen, and inflation making progress toward 2 percent, then it likely would be appropriate to gradually increase the federal funds rate in the coming months,” according to a section that Chalk attributed to the Fed’s thinking when the IMF met with Yellen as well as with staffers in late May and early June.

The 24 executive directors of the fund, which was conceived during World War II to oversee the global monetary system, represent its 189 member nations.

While the impact on the U.S. of the British vote to leave the European Union should be small, risks are skewed to the downside, IMF staff said in an update dated July 8 and included in Tuesday’s release. If downside risks materialize, the Fed should delay interest-rate increases, IMF staff said.

Brexit hasn’t pushed up the dollar as much as expected, while declining Treasury yields have actually loosened financial conditions for consumers and businesses, muting the impact on the U.S., Chalk said. “The net effect on growth is pretty negligible,” he said.

Overall, the U.S. economy is in good shape, the IMF said. The U.S. faces anemic long-term growth, though, unless it takes steps to address a slow-growing labor force, weak productivity and a widening gap between the rich and poor, IMF staff said in the report.

The IMF reiterated its forecast from last month that the U.S. economy will grow 2.2 percent this year and 2.5 percent in 2017.

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