WASHINGTON — St. Louis Federal Reserve Bank President James Bullard said Wednesday he remains concerned about continued low inflation, since there is no good reason for it, and said no one is sure at this point whether the Fed might begin to taper its asset purchase program in December.
During an interview-style discussion at a conference in Chicago, Bullard also said he remains optimistic about the growth prospects for next year, since factors that have been hindering the recovery seem to be disappearing.
While the expectation is that inflation will move back towards the Fed's 2% target, Bullard said, "I continue to be concerned about this issue" as core PCE remains around 1.2%
"We don't have a good story about why this is since we've been easing very aggressively for more than a year," he said. "You would have expected to see more inflation pressure by this point. We haven't seen it. That's what makes me worried more than anything."
The policy-setting Federal Open Market Committee could consider adding an inflation floor to the forward guidance on policy, he suggested, saying the "right level would be 1.5%."
This would be "a promise we wouldn't raise rates so long as inflation was running at very low level. I think that would clarify for people that the Fed doesn't have any intention to be raising rates until we see higher inflation," and that the Fed takes the target seriously and will defend it from low side as well, Bullard said.
"That wouldn't be a change to forward guidance, it would be an addition to forward guidance, to clarify that the inflation side of the mandate is also very important."
He stressed that he does not advocate changing the thresholds the FOMC has set - such as the 6.5% unemployment threshold which Minneapolis Fed President Narayana Kocherlakota suggests should be cut to 5.5%.
If the FOMC starts changing these rates, "then how much credibility do you have for your thresholds?" he said. "I think it might be a dangerous game to move thresholds around."
Instead he said policymakers can reinforce that they will keep rates low even beyond hitting threshold, as Fed Chair Ben Bernanke did again in his speech Tuesday night.
Asked if the possibility of a taper of the Fed's $85 billion a month asset purchase program is on the table for the Dec. 17-18 FOMC meeting, Bullard said no one knows when the taper will begin.
"It's on the table, I'm not sure we're going to do it. I'm not sure if anyone knows at this point," he said.
Fed officials have made it clear the decision will be data dependent, he said, and the cumulative progress in jobs is looking very good.
"I thought the October jobs report was very encouraging. There were also revisions to previous months" so that the three-month average move to 200,000 a month, Bullard said.
"The most powerful argument for tapering is just to point to that," he said, but "the only thing that is holding that back is how sustainable is that going forward, and what about the low inflation."
He repeated that he thinks the unemployment rate is the best job market indicator, despite increased focus on the labor force participation rate which he said has been on a declining trend since 2000 that he believes is due mostly to a demographic shift.
As it ponders when to taper, there remains room to expand the Fed's balance sheet, he said.
"I know that we're taking risks, I know that it might be somewhat harder to exit with a larger balance sheet, but still I think the benefits probably exceed the cost for right now on the balance sheet," Bullard said.
He said the Fed's balance sheet is lower than many other major central banks, which is evidence "maybe there's not as much danger as you think" regarding the large asset holdings.
"It's cold comfort I know, but if you think something bad is going to happen when you get up to the balance sheet is 30% of GDP or 35% of GDP, these other countries should have experienced whatever these bad effects are," he said.
Amid a recovering Europe and improving U.S. housing market, Bullard said he remains optimistic about 2014 because "I think a lot of drags that were affecting the U.S. economy are waning" and "there are a lot of things that are looking good."
Finally, while Bullard said he has advocated cutting to zero the interest paid to banks on excess reserves, the IOER, "I'm not sure there is any momentum for this" even though the FOMC has discussed it.
"I do think with the economy improving probably this won't come back on table," he said. "If the economy took a downturn then I think we would look at it a lot harder."
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