Must-Read: Narayana Kocherlakota: The Fed Needs a Better Inflation Target

Must-Read: Narayana Kocherlakota: The Fed Needs a Better Inflation Target: “A higher goal, with more public support, would benefit the central bank and the economy… https://www.bloomberg.com/view/articles/2017-06-08/republicans-weren-t-smiling-about-comey-or-trump

…Today, a group of economists published a letter urging the U.S. Federal Reserve to consider a monumental change in policy: raising its target for inflation above the current 2 percent. I signed the letter. Here’s why. The inflation target helps define how much stimulus the Fed can deliver when it lowers interest rates to zero (a boundary below which the central bank has been unwilling to go). In a higher-inflation environment, a nominal fed funds rate of zero results in a lower real, net-of-anticipated-inflation rate—the rate that economists typically see as most relevant for consumer and business decisions…. Experience suggests that the Fed could use the added ammunition. During the most recent period of near-zero interest rates, the U.S. unemployment rate remained above 5 percent for nearly seven and a half years (from May 2008 to September 2015). Chair Janet Yellen has suggested that, if another recession takes the Fed to the zero lower bound, the unemployment rate might stay above 5 percent for close to five years. To put it mildly, these aren’t desirable outcomes. The issue is all the more important because periods of zero nominal rates are likely to be more frequent….

The more important part of the letter is its call for “a diverse and representative commission” to re-examine the monetary policy framework—a much more open and transparent approach than the Fed usually takes. When the policy-making Federal Open Market Committee (of which I was a member) chose the 2 percent inflation target in January 2012, its deliberations were completely hidden from the public. As a result, the target has little buy-in from the public and Congress. Canada has demonstrated a better approach. Every five years, its central bank re-examines the monetary policy framework in light of new data and theory, then codifies the framework in an agreement with the government—that is, with the elected representatives of the people. In the most recent review, the Bank of Canada engaged with the public in many ways, including a lengthy description of the process and a guest post by a high-ranking official on a prominent academic blog. The world’s most powerful central bank should be able to do at least as well…