“Some Fed officials also see considerable costs in tolerating more inflation. Stanley Fischer, the Fed’s vice chairman, said at a separate I.M.F. event this month that it was important to keep inflation low enough so that people did not need to pay it any attention. At 2 percent annual inflation, a dollar loses half its value in about 36 years; at 4 percent inflation it takes about 18 years…

…“When you start getting up to 4 percent inflation you begin to see signs of indexation coming back and a whole host of the inefficiencies and distortions,” Mr. Fischer said. A 4 percent target, he concluded, would be “a mistake.””, Binyamin Appelbaum, “2% Inflation Rate Target Is Questioned as Fed Policy Panel Prepares to Meet”, New York Times, April 29, 2015

“Quite unbelievably, in this NY Times article, Fed Vice Chairman Fisher essentially makes Ron Paul’s point about monetary inflation, created by central bankers, causing market inefficiencies (malinvestment I assume?) and distortions. This article should scare the hell out of anyone who owns bonds (especially with the 10-year at only a 2% nominal yield!!!!) and might cause people to run to gold or other hard assets like other commodities, homes, land, vintage autos, art, etc. Maybe the significant rise in value of many of these assets, which once again seem to be approaching bubble levels, is more rational than we think given the inflation risks? Isn’t there really only one reason to seriously consider monetary inflation rates higher than 2% (which Mr. Fisher points out, already causes bonds denominated in dollars to lose 50% of their value every 36 years!!!)? Isn’t it because the government wants to reduce (essentially devalue in real terms) its and others massive debts ($18 trillion or so for the U.S. government), at the expense of creditors? When might these creditors “wake up and smell the coffee?””, Mike Perry, former Chairman and CEO, IndyMac Bank

2% Inflation Rate Target Is Questioned as Fed Policy Panel Prepares to Meet

By BINYAMIN APPELBAUM

Printing plates for making $1 bills. The Fed is preparing to start raising its benchmark interest rate later this year. Credit Mark Wilson/Getty Images

WASHINGTON — The cardinal rule of central banking, in the United States and in most other industrial nations, is that annual inflation should run around 2 percent.

But as the Federal Reserve prepares to start raising its benchmark interest rate later this year to keep future inflation from exceeding that pace, it is facing persistent questions about the wisdom of the rule and the possible benefits of significantly increasing its target.

Higher inflation could disrupt economic activity, but it also would enhance the Fed’s power to stimulate the economy during recessions. And some experts say the struggles of the Fed and other central banks to provide enough stimulus since the Great Recession suggest they could use more room for maneuvering.

“Most developed countries’ central banks have experienced difficulty in providing sufficient monetary stimulus to spur a robust recovery in their economies,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a recent speech in London. “This may imply that inflation targets have been set too low.”

As the Fed’s policy-making committee concludes a two-day meeting in Washington on Wednesday, officials were expected to discuss how much longer the central bank should hold its benchmark rate near zero, as it had done since December 2008. Officials had planned to start raising rates between June and September, but growth has fallen short of the Fed’s expectations this year, which could delay the liftoff.

Inflation has mostly remained well below the 2 percent target since the global economic downturn. The Fed’s preferred measure, published by the Bureau of Economic Analysis, rose just 1.4 percent during the 12 months ending in February.

But Fed officials want to start raising rates in anticipation of stronger growth and faster inflation. William C. Dudley, the president of the Federal Reserve Bank of New York, said last week that “hopefully” the Fed would make its first move this year.

There is little prospect that any major central bank will raise its inflation target in the foreseeable future. Two percent is a global standard and the official line — in Japanese, German and English — is that it was carefully chosen, and that the stability of the target is a virtue in its own right.

There is also considerable political opposition to higher inflation. Some conservative economists and politicians argue that central banks should aim to keep inflation well below 2 percent.

But the broaching of the inflation targeting issue by Mr. Rosengren and other prominent officials — including Olivier Blanchard, chief economist of the International Monetary Fund — suggests an emerging willingness among policy makers to revisit an issue that for more than a generation has been treated as all but written in stone.

The case for raising the 2 percent target rests on the counterintuitive idea that moderate inflation is a good thing, helping to grease the wheels of commerce and prevent an outright fall in prices. This is widely accepted by economists. It is the reason that central banks aim for a modest inflation rate, rather than keeping prices at the same level from year to year. The question is, How much?

Central banks influence economic growth by raising and lowering borrowing costs. Higher costs crimp risk-taking; lower costs stimulate expansion. Those costs, expressed as interest rates, combine the price of money with an additional increment to compensate for inflation. Higher inflation means rates will run higher in normal times, allowing the Fed to make larger cuts during periods of duress.

In recent decades, as inflation generally declined, the Fed has had less room to make cuts. The Fed, for example, cut rates by 6.75 percentage points beginning in 1989, and by 5.5 points beginning in 2001. On the eve of the crisis in 2007, the Fed’s benchmark rate stood at 5.25 percent. The Fed rapidly reduced that rate almost to zero — but that did not provide enough stimulus on its own to revive the economy.

Laurence Ball, an economist at Johns Hopkins University, proposed in a 2013 paper that central banks should adopt 4 percent inflation targets. The benefits of avoiding a return to the so-called zero lower bound, he said, outweighed the potential economic disruption.

“A 2 percent inflation target is too low,” he wrote. “It is not clear what target is ideal, but 4 percent is a reasonable guess, in part because the United States has lived comfortably with that inflation rate in the past.”

The case for a higher target has been strengthened in recent years by a global decline in borrowing costs, which might be offset by higher inflation.

In April 2012, Fed officials predicted that the benchmark rate would return to about 4.2 percent after the economy had recovered. In the Fed’s most recent predictions, in March, the average estimate was that the rate would reach 3.7 percent.

And some economists regard even those estimates as optimistic. Lawrence H. Summers, the former Treasury secretary, argues that the developed world may have entered a period of “secular stagnation” in which borrowing costs are unlikely to rise significantly above current levels because of chronic lack of demand.

John Williams, president of the Federal Reserve Bank of San Francisco, said in an interview this month that if Mr. Summers was correct, it might become necessary for the Fed to consider raising its 2 percent target.

“If you really thought that’s the world we’re in because of the demographics or productivity growth — if that’s really what our future holds — I think that’s just a reality that you need to think about monetary policy and its ability to achieve goals,” Mr. Williams said.

But Mr. Williams, like most central bankers, is not yet ready to do so.

He said the Fed had demonstrated in recent years that it retained considerable power to stimulate growth even after cutting rates nearly to zero through bond purchases and by announcing that it intended to keep rates near zero for an extended period.

David Lipton, the senior American official at the I.M.F., said recently that the crucial lesson was that central banks needed to take such measures more quickly. “It isn’t necessarily that you ought to be at 3 or 4, it’s that when you’re at 2 you’re just much more careful about preventing it from falling,” he said.

It is also possible that rates will increase more than the Fed expects, easing the pressure. Ben S. Bernanke, the former Fed chairman, has argued in response to Mr. Summers that rates are being suppressed by a “savings glut” in some countries, notably Germany, that is likely to dissipate as growth improves.

James Hamilton, a professor of economics at the University of California, San Diego, co-wrote a recent paper that reached a similar conclusion.

“Those who see the current situation as a long-term condition for the United States are simply overweighting the most recent data from an economic recovery that is still far from complete,” Mr. Hamilton wrote in a blog post.

Fed officials also see benefits in maintaining the 2 percent target, which was formalized in 2012 but had long been acknowledged informally. People have come to view 2 percent inflation as a reliable constant. When oil prices rose in the middle of the last decade, measures of inflation expectations showed that American consumers remained confident the effects would subside. In recent years, as inflation has consistently fallen short of the Fed’s goals, those same measures show that confidence in an eventual rebound has not wavered.

“I don’t see anything magical about targeting 2 percent inflation,” Mr. Bernanke said at a panel sponsored by the I.M.F. But he added that the costs and disruptions of moving to a higher target could outweigh the benefits.

A higher inflation target also would require political support. Congressional Republicans already are upset that the Fed is trying to raise inflation back toward 2 percent. They would loudly object to any effort to enshrine a higher target.

Some Fed officials also see considerable costs in tolerating more inflation. Stanley Fischer, the Fed’s vice chairman, said at a separate I.M.F. event this month that it was important to keep inflation low enough so that people did not need to pay it any attention. At 2 percent annual inflation, a dollar loses half its value in about 36 years; at 4 percent inflation it takes about 18 years.

“When you start getting up to 4 percent inflation you begin to see signs of indexation coming back and a whole host of the inefficiencies and distortions,” Mr. Fischer said. A 4 percent target, he concluded, would be “a mistake.”

A version of this economic analysis appears in print on April 29, 2015, on page B1 of the New York edition with the headline: Issue for Fed: Is a 2% Inflation Rate High Enough?.

Posted on April 29, 2015, in Postings. Bookmark the permalink. Leave a comment.

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