Federal Reserve vice chairman Donald Kohn said Friday that “temporarily” tolerating an “above-normal” rate of inflation as the economy recovers, as some macroeconomic theory suggests, would run the risk of undermining now-stable inflation expectations in a costly way.
Well-anchored inflation expectations have been crucial to the Fed’s ability to respond flexibly to the financial crisis and will help support the recovery, Kohn said. His implication seemed to be that the Fed will not keep monetary policy highly accommodative beyond the point at which wage-price pressures begin to appear.
Kohn, in remarks at a Fed conference on monetary economics in Washington, acknowledged that the models used by the Fed and other central banks did not fully anticipate the “feedback loop” between asset prices, credit flows, and economic activity. He said the collapse of the housing bubble showed just how important that linkage is.
As for targeting asset prices in the future, as Fed critics and some officials have urged it to do, Kohn said it is difficult to correctly assess the fundamental value of an asset. Nevertheless, he suggested that the Fed does need to make a greater effort to work asset prices into its policymaking because of the high cost of the collapse of housing prices.
—Market News International
