Noting that inflation below 2% "is just as much of a problem" as inflation greater than 2%, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota called on the Fed to set a "benchmark two-year time horizon" to get inflation to 2% and added it would be "inappropriate" to raise rates next year.
"The time is right to consider sharpening the FOMC's statement of its objectives in several ways," Kocherlakota said Tuesday, according to prepared text of his speech, released by the Fed.
The clarifications which he suggested, would be clarifying that the "inflation objective is symmetric," indicating that inflation above or below 2% is problematic.
"Why do I see symmetry as important? Without symmetry, inflation might spend considerably more time below 2 percent than above 2 percent. Inflation persistently below the 2 percent target could create doubts in households and businesses about whether the FOMC is truly aiming for 2 percent inflation, or some lower number," he said. "This kind of unmooring of inflation expectations would reduce the effectiveness of monetary policy as a mitigant against adverse macroeconomic shocks."
As for the two-year benchmark, Kocherlakota explained, "Two years is a good choice for a benchmark because monetary policy is generally thought to affect inflation with about a two-year lag."
Currently, the Federal open Market Committee has a 2% long-run inflation target, but "it has not specified any time frame for achieving that objective. This lack of specificity suggests that appropriate monetary policy might engender inflation that is far from the 2 percent target for years at a time and thereby creates undue inflation (and related employment) uncertainty. Relatedly, the lack of a public timeline for a goal can sometimes lead to a lack of urgency in the pursuit of that goal. I believe that, if the FOMC publicly articulated a reasonable time benchmark for achieving the inflation goal, the Committee would be led to pursue its inflation target with even more alacrity."
He defended the policy against potential critics by noting "many central banks incorporate a similar timing benchmark."
Inflation won't return to 2%, in Kocherlakota's estimation, until 2018. "This sluggish inflation outlook implies that, at any FOMC meeting held during 2015, inflation would be expected to be below 2 percent over the following two years. It would be inappropriate for the FOMC to raise the target range for the fed funds rate at any such meeting."
But, he stressed, liftoff would have to be data dependent. "The language changes to the framework statement that I've suggested would not tell the public exactly when interest rates are going to rise. But these changes would allow the public to have a better understanding of what kind of data would engender the first interest rate increase."
Labor markets have not fully recovered since the Great Recession began in 2007, leaving the Fed short on both its mandates. "Unfortunately, monetary policy has proven to be insufficiently accommodative to offset either the price or employment effects of this large shock," he said.
