My Bloomberg colleague Michael McKee asked a really good question at Janet Yellen’s press conference Thursday: If the Federal Open Market Committee expects below-target inflation for years, why do most its members think a rise in interest rates before the end of this year is called for?
The headline from the statement was that interest rates are staying at zero for the moment. But among the materials released with the announcement is the so-called dot-plot, which displays each FOMC member’s “judgment of the midpoint of the appropriate target range for the federal funds rate.” This shows that 13 of the 17 participants expect a first rise in interest rates to be warranted before the end of this year.
Turning to another page of the FOMC’s forecast, you see projected inflation remaining below the target rate of 2 percent for three more years — it eventually gets to 2 percent at the end of 2018. On the face of it, even allowing for lags in monetary policy, the prospect of three years of below-target inflation does not argue for an increase in interest rates by December of this year.
…If the Fed doesn’t want to publish a forecast showing inflation rising above 2 percent, it should perhaps acknowledge that its target is indeed a ceiling. And then, having done that, it should perhaps raise the ceiling to 3 percent.
Admittedly, the limits to the Fed’s efforts to stimulate the economy are partly prudential. At the recent meeting of its policy committee, dissenters questioned whether it was right to promise explicitly, as the central bank has, two more years of very low interest rates. Inflation hawks resist the idea of further QE. Here is the central point, however: this is a disagreement about whether further stimulus would be wise, not whether it is possible.
In my view, it is both possible and necessary. The recent revisions to the figures for growth make the economic argument so strong that I wonder if politics is not influencing the dissenters. The problem is that the Fed has to explain itself, both to Congress and to the public at large. Conditions demand what critics would call an “inflationary” monetary stimulus. The Fed’s vague mandate, which calls for both price stability and full employment, is not much help. It is a fight the Fed would rather avoid.
To make the case for new stimulus, the Fed needs better arguments. The past few weeks have settled, to my satisfaction at least, a long-running debate on this very topic. Rather than targeting inflation, central banks should keep nominal incomes growing on a pre-announced path: say 5 per cent a year. Nominal gross domestic product is the sum of inflation and growth in real output – and is the variable that monetary stimulus directly drives.