The Fed has a shorter horizon for its wide-ranging review of strategies, tools and communications practices –- an idea borrowed from the Bank of Canada. It’s seeking outside views, and aims to reach conclusions in the first half of next year.
Front and center is what to do about inflation. Powell has ruled out raising the 2 percent target. But he’s also evinced concern about the risk of the U.S. falling into a disinflationary spiral.
That’s what happened to Japan more than two decades ago –- with disastrous results. Because the Japanese expected prices to keep falling, consumers put off purchases and companies shelved expansion plans, and zero-rates policy at the central bank failed to entice them. Eventually, a combination of cheap money and budget deficits succeeded in shoring up demand, but only after years of lost growth.
‘Seductive Idea’
In a March 8 speech, Powell suggested one way to battle the “low inflation syndrome’’ from the monetary side. He said the Fed could adopt a “make-up’’ strategy -- letting inflation run above-target during good times like now, to offset the periods of slower price rises.
The aim would be to cement the public’s view of where prices are headed, and so avoid the deflationary trap that snared Japan. “We want inflation expectations to be anchored at around 2 percent,’’ Powell told CBS in an interview aired March 10.
There are risks, of course. If consumers and companies decide that the goal of price stability has been abandoned, then inflation could rise a lot higher than the Fed wants –- as in the 1970s when it reached double digits.
MMT-type fiscal policy carries perils as well. It could open the floodgates to a rush of costly programs. “It’s a very seductive idea,’’ said Maya MacGuineas, president of the non-profit Committee for a Responsible Federal Budget. “I can spend money on everything.’’
And, taken together, a laissez-faire approach to both inflation and deficits could awaken the bond vigilantes and send long-term interest rates shooting skyward.
In the end though, the U.S. may have little choice but to adapt policy to the looking-glass economy it’s stuck with. The same applies in much of the industrial world, Summers argued in a paper this month co-authored with Bank of England Senior Economist Lukasz Rachel. Without a forceful response, he wrote, it’s “at risk of mirroring the experience of Japan.”
This article was provided by Bloomberg News.