The Federal Open Market Committee is still missing on both sides of its dual mandate: "undershooting its price stability objective" and "underperforming with respect to its maximum employment objective," Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Tuesday.
Inflation has averaged 1.5% since 2007, the beginning of the Great Recession, and had been below 2% since the FOMC adopted that as a target in January 2012, Kocherlakota said.
"So, whether we look over the past six years or over the past two years, inflation has been running too low to be consistent with price stability," Kocherlakota told the Minnesota Business Partnership, according to prepared text released by the Fed. "The good news is that the FOMC does expect inflation to turn back toward 2%. However, that return to 2% could take a long time. For example, the minutes from the April FOMC meeting reveal that the Federal Reserve Board staff outlook is for inflation to remain below 2% over the next few years. In a similar vein, earlier this year, the Congressional Budget Office (CBO) predicted that inflation will not reach 2% until 2018-more than 10 years after the beginning of the Great Recession."
The chance that inflation will average more than 2% over the next four years is "considerably lower" than the odds that inflation will average less than 2% during that span, he said. "And that's why I conclude my discussion of inflation by saying that the FOMC is undershooting its price stability goal."
This indicates "a significant problem in our economy" and the wasting of resources, especially human resources. This, he said, "typically means that the FOMC is also underperforming on its other objective of promoting maximum employment."
Below target inflation means "a significantly lower price level." Kocherlakota added, "If my inflation forecast is right, the price level in 2018 will be about 2.2% below what it would have been had the FOMC hit its inflation target over the preceding six years."
By continuing to target 2% inflation after 2018 would mean "the price level will be permanently 2.2% lower than was expected in 2012."
Rather than this approach, inflation targeting, Kocherlakota suggested, "the FOMC could target a slightly higher inflation rate for a few years after 2018 in order to make up for the shortfall in the price level. This latter policy approach is often termed price level targeting."
Price level targeting "would serve as an automatic stabilizer for the economy." Since inflation is below target when demand is low, price level targeting, allows the FOMC to make up for "low inflation by using monetary policy to stimulate higher future inflation and higher future demand. But this prospect of higher future demand is an incentive for businesses to hire and invest more now. Thus, with price level targeting, the FOMC's anticipated future policy choices automatically offset current adverse shocks."
While employment levels have improved, the rate has been "painfully slow," and unemployment is still above its long-range level, which Kocherlakota sees as "just over 5 percent." Also, the unemployment rate is down, in part, "because the fraction of people who are looking for work has fallen."
"As a consequence, there is still significant underutilization of our country's most important resource-its people," he said.
