The newly announced Federal Open Market Committee forward guidance "weakens the credibility" of the Fed's "commitment to target 2 percent inflation" and increases policy uncertainty, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said in explaining why he voted against the statement.
Noting that the FOMC's latest statement was "unusually significant," Kocherlakota said, "I dissented from the new guidance for two reasons. The first reason is that the new guidance weakens the credibility of the Committee's commitment to target 2 percent inflation. The second reason is that the new guidance fosters policy uncertainty and thereby suppresses economic activity."
The personal consumption expenditure has slipped down in the past few years and is now near 1%, he said in a statement released by the Fed Friday. The forward guidance omits any plan to "facilitate a more rapid increase of inflation back to the 2 percent target. The absence of this kind of communication weakens the credibility of the Committee's inflation target, by suggesting that the Committee views persistently sub-2-percent inflation as an acceptable outcome."
The economy remains "well short of maximum employment," Kocherlakota noted, yet the Fed statement "provides little information about its desired rate of progress toward maximum employment. Indeed, the guidance provides little quantitative information about what would characterize maximum employment. These omissions create uncertainty about the extent to which the Committee is willing to use monetary stimulus to foster faster growth, and this uncertainty is a drag on economic activity."
Hailing the FOMC's forward guidance for the past 15 months, Kocherlakota said, it "has been highly effective at shaping market expectations. That guidance has relied on an unemployment rate threshold of 6.5 percent and an inflation outlook guardrail of 2.5 percent. Given the effectiveness of this quantitative approach, I would have favored adopting a similar approach going forward."
Language he suggested toward this end was: "the Committee anticipates keeping the fed funds rate in its current range at least until the unemployment rate has fallen below 5.5 percent, as long as the one-to-two-year-ahead outlook for PCE inflation remains below 2¼ percent, longer-term inflation expectations remain well-anchored, and possible risks to financial stability remain well-contained."
Such a statement shows the FOMC's "willingness to use monetary policy tools to push inflation back up to 2 percent. It reduces macroeconomic uncertainty by being clearer about the kinds of labor market and inflation conditions that are likely to be associated with an increase in the fed funds rate. Finally, it deals with the unlikely possibility of risks to financial stability through an explicit escape clause."
Finally, Kocherlakota's statement had kind words for the portion of the FOMC statement that "provides information about the Committee's intentions for the behavior of the fed funds rate once employment and inflation are near mandate-consistent levels. Those intentions are appropriate, and communicating them should help stimulate economic activity by reducing uncertainty about the likely path of the fed funds rate once the Committee's goals are reached."
