Williams Says Fed Should Rethink Price Policy Before Next Crisis

  • Price-level target would help stabilize economy, he says
  • “It’s better to study and debate these issues now”: Williams

The U.S. Federal Reserve and other central banks should consider adopting a new strategy to make up for past deviations from their inflation targets, said San Francisco Fed President John Williams.

The shift would allow central bankers to guide inflation above their targets for a time to make up for past undershoots, or vice versa. It’s a strategy that would boost their ability to stabilize the economy in a time of low interest rates, Williams said Friday in remarks prepared for a speech in New York.

“The big advantage of this approach is that any surges or drops in the inflation rate need to be made up in the future,” he said. “This assures that, over the medium term, inflation stays on track.”

The approach the Fed currently takes is to guide inflation back to its 2 percent target when shocks drive it away from that rate, before trying to stabilize it there. As inflation has risen close to their goal over the past several months, Fed officials have said they wouldn’t be alarmed if it rose above target, though they are not trying to intentionally overshoot. The strategy Williams discussed would allow inflation to remain above 2 percent for some time.

The policy “creates a positive feedback loop where stable inflation anchors inflation expectations, which in turn fosters stable inflation,” Williams said.

The so-called price-level targeting approach would have helped the Fed avoid the “Great Inflation” of the 1960s and 1970s, he said.

“We re-examined the choices made by policy makers to determine whether the devastating increases in inflation and unemployment that became known as stagflation could have been avoided,” Williams said. “Our findings suggest that answer was yes, they could have -- if the Fed had instead used an alternative, robust policy strategy that effectively targeted the price level, as well as responded to the unemployment rate.”

Now is the time to consider alternative strategies to employ in the next downturn, Williams said, adding the current outlook for low interest rates would leave the Fed with little ability to stimulate the economy with rate cuts.

“It’s better to study and debate these issues now, when we’ve attained recovery, than to wait for the next downturn or crisis to hit,” he said. “A price-level framework merits very serious consideration for central banks including the Fed.”

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