Fed’s trying to find ‘makeup’ inflation strategy that works, Powell says

Fed Vice Chairman Richard Clarida has been leading the central bank’s year-long strategic review.

The U.S. central bank is trying to find some form of “makeup” inflation strategy that works, Fed Chairman Jerome Powell said Tuesday.

“We are looking at all those make-up ideas to try to find a credible, practical, actionable, sort-of framework the public would understand and act on,” Powell said during a moderated discussion at the Council on Foreign Relations in New York.

Powell didn’t suggest that the decision had been made and the work had been completed, but he praised the idea, calling the thinking behind makeup strategies “fairly clever.”

The Fed strategic review has been led by Fed Vice Chairman Richard Clarida. The central bank is going to discuss makeup strategies and a wide range of other potential policy innovation during meetings over the second half of the year. Decisions might not be reached until 2020.

At the moment, the Fed has a 2% annual inflation target but the central bank does not take into account where inflation had been previously.

Under a “makeup” strategy, the Fed would take account of when the economy is weak and inflation is low, and “promise” to allow inflation to run a bit above target when the economy recovers.

Economic models show that, if the public finds this Fed promise credible, consumers would bring forward their spending plans, and thus help end the downturn in the economy.

“The world is not a model…notwithstanding that, it is an interesting insight,” Powell said.

Some Fed officials question whether it is credible to promise make-up strategies.

“One needs to ask whether it is credible for policy makers to commit to keep interest rates low to make up for past shortfalls of inflation from target even when demand is growing strongly or to act to bring inflation down in the face of a supply shock by tightening policy even in the face of weak demand,” said Cleveland Fed President Loretta Mester in May.

Regarding interest-rate policy, the Fed chairman also said the central bank is grappling with how uncertainties over trade policy will slow the U.S. economy and thus call for policy accommodation.

And during his remarks, Powell expanded on his opposition to raising the Fed’s 2% inflation target to 4% as some prominent economists have championed. The Fed chief said Congress may wonder whether a 4% inflation target meets the statutory definition of “price stability.”

Stocks slipped on Tuesday as investors were disappointed Powell was not certain about the need for more central bank stimulus in the near future, with the Dow Jones Industrial Average DJIA, -0.67%   down over 180 points.

[“source=marketwatch”]