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Fed's Debates Inflation Targets in Post-Greenspan Era (Update1)

Fed's Debates Inflation Targets in Post-Greenspan Era

March 22 (Bloomberg) -- In 1995, then-Governor Janet Yellen was the Federal Reserve's most vocal critic of using inflation targets to set monetary policy.

Now the president of the Fed Bank of San Francisco, Yellen has joined a growing number of regional Fed leaders who support numerically defining price stability, breaking with Chairman Alan Greenspan and other Washington-based governors. If stable prices are one of the Fed's goals, ``the public deserves an answer'' about what that means, she told reporters March 14 in Kauai, Hawaii.

The inflation-target debate's eventual outcome may shape the Federal Open Market Committee's approach in the coming post- Greenspan era, which begins when the 79-year-old chairman's non- renewable term as governor ends on Jan. 31.

``The idea seems to have developed some additional momentum lately, and the impending transition in the chairmanship may be playing an underlying role,'' said Al Broaddus, the former president of the Richmond, Virginia, Fed, who retired in July. ``It's an issue that divides monetary economists, including FOMC members, fairly sharply into two camps.''

The targeting question caused more controversy at the FOMC's Feb. 1-2 meeting than whether to raise interest rates, according to the minutes of the meeting. The debate may resume today, when the FOMC meets again; the median forecast of 105 economists in a Bloomberg News survey is that the central bank will raise its target rate a quarter point to 2.75 percent, the seventh increase in a row.

Supporters

The policy meeting began at 9 a.m. Washington time, a Fed spokesman said. The decision is expected around 2:15 p.m.

Producer prices accelerated 0.4 percent in February, led by higher costs for gasoline and food, the Labor Department said today in Washington. The core rate, which excludes food and energy, rose 0.1 percent, and is up 2.8 percent from February of last year, the biggest 12-month rise since November 1995.

Including Yellen, five of the 12 regional Fed presidents support inflation targets. The others are Gary Stern of Minneapolis, Anthony Santomero of Philadelphia, William Poole of St. Louis and Jeffrey Lacker of Richmond. In addition, two of the Fed's Washington-based governors back the idea: Edward Gramlich and Ben Bernanke, whose name occasionally surfaces as a potential successor to Greenspan.

Speaking Against Targets

``If Ben Bernanke were still there and he were to become chairman, I would think he would be able to talk his colleagues into just sort of doing it,'' Robert McTeer, who left the Fed in November to become chancellor of the Texas A&M University System, said in a March 2 interview. ``But I don't think that will happen.''

Greenspan, who has led the Fed since 1987, reiterated his opposition to inflation targeting in testimony before the U.S. House Budget Committee on Feb. 25, 2004. ``I'm not sure that would actually enhance the capability of our doing a better job,'' he said.

Aside from Greenspan, governors who have spoken against targeting are Roger Ferguson, the Fed board's vice chairman, and Donald Kohn. A sixth governor, Mark Olson, said he is skeptical, although he hasn't ruled out the idea. The seventh, Susan Bies, hasn't stated her position.

Four Fed bank presidents say they are skeptical or oppose targeting: Chicago's Michael Moskow, New York's Timothy Geithner, Boston's Cathy Minehan and incoming Dallas President Richard W. Fisher. The remaining three, Thomas Hoenig of Kansas City, Atlanta's Jack Guynn and Sandra Pianalto of Cleveland, haven't taken recent public stands on the topic.

Ending Stimulus

Moskow says that a target might undercut the central bank's dual mandate of price stability and maximum employment and that there's not enough evidence to show targeting works.

``It's not something that you want to move into right away,'' he told reporters March 9. ``Inflation, we don't believe, is a problem.''

The debate is taking place as central bankers attempt to lift borrowing costs to a level where monetary policy no longer stimulates the economy, in order to head off future inflation. The Fed's preferred inflation measure, the Commerce Department's personal consumption expenditures price index minus food and energy, rose 1.6 percent in 2004 and is forecast by the central bank to increase as much as 1.75 percent this year. The index is near the range of price stability as defined by Fed presidents including Yellen.

A `Deep' Split

A Bloomberg survey published yesterday showed 13 of the 22 bond firms that trade government debt directly with the Fed expect the FOMC to drop language about the ``measured'' pace of rate increases by June, with three saying the change may come as soon as today. John Herrmann, director of economic commentary at Cantor Fitzgerald LP, which is not a primary dealer, said in an interview today the Fed should change its language today to say ``it will depend on the flow of data.''

At its Feb. 1-2 meeting, the FOMC discussed the pros and cons of defining a price-stability objective, either as a range or a specific number. According to the minutes of the meeting, all seven governors and 12 presidents agreed that stable prices provide the best way to maximize sustainable economic growth in the long run. They disagreed, though, about whether to define low inflation for the public and deferred the discussion without specifying when they would take it up again.

``This is, within the Fed, an academic argument, and the split is pretty deep,'' said David Jones, a former economist at the New York Fed.

When Greenspan Leaves

The FOMC previously discussed the issue 10 years ago, when Congress was considering a bill that would have declared price stability the Fed's primary objective and established an inflation target of 0 to 2 percent.

The measure was introduced by then-Senator Connie Mack, a Florida Republican, who said in a recent interview that he introduced it out of ``fear about what might happen'' when Greenspan left office. At the time, Greenspan appointed Yellen to make arguments against numeric goals; the bill never passed the Senate.

Yellen, 58, came out in favor of setting inflation goals in a March 2 speech in San Francisco. ``Because she has persuasively argued the case against inflation targeting, anything she says in favor of it would likely get extra attention from participants in the debate,'' said Tom Schlesinger, executive director of Financial Markets Center in Philomont, Virginia, which follows the Fed.

Not the Sole Goal

Yellen said in Kauai that she ``strongly'' opposes making inflation the sole objective of the central bank and might even allow prices to rise ``above any rate I was comfortable with'' to keep employment steady in unusual circumstances. Those sentiments aren't inconsistent with her support of inflation targeting, she said. ``I can tell you numerically what I mean by price stability without making that the only objective that I think monetary policy should serve,'' she said.

Countries such as Britain and New Zealand began using numeric targets as the basis for monetary policy to help convince the world they were serious about containing inflation and to build their credibility.

The European Central Bank targets inflation close to 2 percent. At an April 2004 speech in New York, ECB President Jean- Claude Trichet said he still considers the bank to be closer to a U.S. model than to the U.K. or other nations that rely on strict inflation forecasts. ``We are not the prisoner'' of inflation forecasts, he said.

Canada's Experience

Canada's experience with inflation targeting has been beneficial and shows the concerns raised by the FOMC are overstated, Bank of Canada Governor David Dodge said yesterday. Canada's central bank also tries to hit a 2 percent inflation target.

``I'd be hard put to advise the Fed on what it should do,'' Dodge said in an interview. ``But what I can say is that for us it has been very helpful, both in gaining credibility but more importantly perhaps now that we have that credibility, in maintaining it.''

In the U.S., the issue gained new life after Princeton University economist Bernanke, co-author of the book ``Inflation Targeting: Lessons From the International Experience,'' joined the central bank in August 2002. Santomero gave his support in 2003; Stern and Lacker joined Yellen in doing so this year.

Targeting ``is a subject of broad interest to much of the committee,'' Yellen said. Whether it continues to be discussed ``probably depends in part on who the next chairman is.''


LINK: http://www.bloomberg.com/apps/news?pid=10000103&refer=us&sid=a5RThzk7q_2M