Targeting price level rather than inflation should be considered by the Federal Reserve, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Wednesday.
"[T]he question of whether to target the inflation rate or the price level should be a subject for serious discussion among central bankers," he told the Economic Club of Minnesota, according to text released by the Fed.
Inflation has been "too low to be consistent with price stability" for six years, and it could be four more years before inflation hits the Fed's 2% target, according to Kocherlakota's projections, and the Congressional Budget Office.
"To sum up: The FOMC is undershooting its price stability goal," he said. 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."
Kocherlakota called the 6.3% unemployment rate "not healthy," adding, "this measure-troubling as it is-could well overstate the degree of improvement in the U.S. labor market" since the number of people looking for jobs has fallen since 2009, which would bring down the jobless rate.
While the labor market has improved, he said, "the rate of improvement over the past four-plus years has been painfully slow."
Below target inflation mean "a significantly lower price level." Kocherlakota added, "If my inflation forecast is right, the price level in 2018 will be about 2.5 percent 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 2.5 percent 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."
