Expounding on the reason why his dissented on the Federal Open Market Committee decision this week, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota explained in a statement Friday the medium-term outlook for inflation hasn't improved this year, and could be worse.
"I felt that the FOMC needed to reduce possible downside risk to the credibility of its 2 percent inflation target by taking more purposeful steps to move inflation back up to 2 percent," the statement said.
When QE3 was announced, the FOMC said it would monitor inflation to ensure it would "move back toward its objective over the medium term," Kocherlakota noted. "At this stage, I see no such evidence. In my assessment, the medium-term outlook for inflation has shown no overall improvement since last December and, indeed, is arguably worse. Failing to act in response to this subdued inflation outlook increases the downside risk to the credibility of our 2 percent inflation target. Market-based measures of longer-term inflation expectations have fallen recently to unusually low levels, a decline that I believe reflects that kind of increased downside risk."
Pointing to Japan, and possibly Europe, as examples of central banks with credibility woes, Kocherlakota warned, "central banks need to take actions on an ongoing basis to ensure that inflation stays at target. In light of the evolution of the data over the past few months, I believe we needed to take such actions on Wednesday."
Two actions Kocherlakota suggested as appropriate were: the Fed could have continued buying $15 billion of longer-term assets a month; or "committed to keeping the target range for the federal funds rate at its current level at least until the one- to two-year-ahead inflation outlook has risen back to 2 percent, as long as risks to financial stability remain well-contained."
By taking either of these steps, the FOMC would have "communicated" its determination to get inflation back to 2% as quickly as possible and "put upward pressure on the demand for goods and services and on prices."
