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Friday, June 29, 2007

A Third Inflation Regime?

There is news today that "Core US inflation falls below 2%." Here is core inflation as calculated by the Dallas Fed since they started keeping track of this statistic:


Whatever we hear about target inflation rates and target ranges, practically in recent years there have been two inflation regimes for the core measure, the 4% regime from about 1983 to 1990, a transition period from 1991 through 1993, then a 2% regime ever since.  The question is whether the Fed will be satisfied to stabilize inflation around 2% as it has recently, or whether it intends to stabilize at a new, lower target establishing a third regime.

Here's what Greg Ip had to say in the WSJ's Economics blog (see David Altig too):

Fed Statement: Agnostic on Inflation Target, by Greg Ip: With core inflation at 2% in April and perhaps about to go lower, Thursday’s policy statement by the Fed dropped its reference to inflation as “somewhat elevated.” Some analysts saw this as acknowledgement of an inflation target somewhere around 2%.

More likely, the Fed simply punted on the question.

When core inflation was at 2.4%, as it was as recently as February, it was relatively easy for members of the Federal Open Market Committee to agree inflation was “elevated.” No member apparently thinks a number that high represents price stability.

At 2%, the question gets stickier. Some Fed officials say their comfort zone is 1% to 2%, and inflation above the 1.5% midpoint of that range leaves them unsatisfied. But some others, who have not publicized their views, don’t share that. Extensive staff work, plus the experience of foreign central banks, have suggested 2%, or something slightly lower, might be better. That number would makes deflation less likely and avoid the potential costs of forcing the public to adjust to a lower inflation rate.

As is well known, the FOMC is deep into a lengthy internal discussion of communication issues, including the question of an inflation target. Until that’s settled (if it ever is – progress has been slow), the FOMC, in its official pronouncements, is likely to remain agnostic on the appropriate inflation rate. Dropping the reference to “elevated” without replacing it with anything may have been necessary to satisfy those who don’t buy into the 1% to 2% comfort zone without arousing objections from those who do.

On the communication issue, I don't see any reason why the Fed cannot (and should not) tell us whether they intend to stay at 2%, as in the recent past, or whether they intend to take inflation lower unless, as suggested, they don't know themselves due to internal dissent. In any case, they should settle this and tell us how they intend to proceed.

    Posted by on Friday, June 29, 2007 at 12:24 PM in Economics, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (26)


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