Fed begins tussle over practical meaning of new inflation policy

WASHINGTON: Federal Reserve policymakers on Friday began fleshing out what their new tolerance for inflation will mean in practice, an issue critical to how investors and households reshape their own outlooks even if it may not be relevant to any immediate decisions by the US central bank.

The new policy, laid out in a strategic document last month and incorporated into a policy statement issued on Wednesday, pledges to keep interest rates near zero until inflation has hit the Fed's 2% target and is on track "to moderately exceed" it "for some time."

As it stands, with the coronavirus pandemic sapping demand, leaving millions unemployed, and threatening the survival of entire industries, inflation is not seen as the core risk. New economic projections released by the Fed this week show inflation only reaching 2% by the end of 2023, with any shift towards tighter monetary policy likely years down the road.

But how the Fed's new language is interpreted by the central bank's five current Washington-based governors and 12 regional bank presidents will be central to whether bond markets, stock investors and even consumers see the new approach as likely to be effective, and start behaving in a way that actually helps push inflation higher.

After years of weak inflation, that is the Fed's hope. It is based on fears of a Japanese-style low inflation rut that can have its own damaging effects over time, and Fed officials on Friday started to outline their views of how to proceed.

Atlanta Fed President Raphael Bostic said, for example, that he'd be paying closer attention to how fast inflation rises rather than on its quarter-to-quarter level in implementing the new approach.

In an interview on Bloomberg Television, Bostic said if inflation went up to 2.3% but appeared stable "that would be fine ... By contrast if we were at 2.2 and the next quarter at 2.4 and then at 2.6, that trajectory would give me concern" and perhaps require efforts to cool the economy.

Minneapolis Fed President Neel Kashkari, in contrast, laid out a more open-ended view in written comments describing why he dissented against the rate-setting Federal Open Market Committee's policy statement on Wednesday.

The Fed, he felt, was setting itself up to make the same mistake it has in the past of reacting too quickly to inflation "ghost stories" and risked nipping off job growth too soon.

He said the Fed instead should switch its focus to core inflation, a slower moving variable that excludes volatile commodity prices, and ensure that it reached 2% on a "sustained basis."

"I would have preferred the Committee make a stronger commitment to not raising rates until we were certain to have achieved our dual mandate objectives," of maximum employment consistent with stable prices, Kashkari said in an essay.

A second dissent from Dallas Fed President Robert Kaplan argued the central bank should keep its options open to raise rates sooner if needed - a sign of the broad debate now taking place over just what the new framework will mean in practice.