The Federal Open Market Committee’s decision to set a 2% explicit, numerical inflation target is “an important step forward” that could stop the nation from misreading the output gap and thereby avoiding a “looming disaster” caused by keeping rates near zero for too long, according to Federal Reserve Bank of St. Louis president and chief executive James Bullard.
“This is an important development, as it may prevent the U.S. from repeating the mistakes of the 1970s, in which a misreading of the size of the output gap led the Fed to maintain easy monetary policies for far too long,” Bullard told the Union League Club of Chicago, according to prepared text of the speech released by the Fed.
Recently, the belief sprung up that a very large “output gap” that keeps “inflation at bay” exists “and is fodder for keeping nominal interest rates near zero into an indefinite future,” Bullard warned.
If that were the case, he said, it would be “very difficult for the United States to ever move off of the zero lower bound on nominal interest rates,” which would be a “looming disaster.”
A near-zero rate policy “has its own costs,” he said. “If we were proposing to remain near zero for a few quarters, or even a year or two, one might argue that such a policy matches up well with the short-term business cycle dynamics of the U.S. economy. But a near-zero rate policy stretching over many years can begin to distort fundamental decision-making … in ways that may be destructive to longer-run economic growth.”
“High inflation just causes problems,” Bullard said.
