In historic shift, Fed sets inflation target

Thu Jan 26, 2012 1:37pm GMT

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(Reuters) - The U.S. Federal Reserve took the historic step on Wednesday of setting an inflation target, of 2 percent, a victory for Chairman Ben Bernanke that brings the Fed in line with many of the world's other major central banks.

The U.S. central bank, in its first ever "longer-run goals and policy strategy" statement, said, however, it was not appropriate to adopt a fixed goal for employment because the level of unemployment that can be achieved without sparking inflation is not largely determined by monetary factors.

The inflation target is at the high end of what was traditionally seen as an informal target range of roughly 1.7 percent to 2 percent and caps Bernanke's crusade to improve communications at what for years had been purposefully opaque and secretive deliberations at the Fed.

The target aims to make the central bank more effective at controlling growth.

The Fed said the 2 percent target - measured by the annual change in the price index for personal consumption expenditures - is the most consistent over the long run with its mandate.

"Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the committee's ability to promote maximum employment in the face of significant economic disturbances," the Fed said.

Sceptics, particularly among congressional Democrats, have in the past worried that such an explicit inflation target would relegate the Fed's other congressionally set mandate, full employment, to the back burner.

But on Wednesday the Fed said policy decisions "must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision."

TIMELY MOVE

While Bernanke, the plainspoken successor of Alan Greenspan, has touted a numerical inflation goal as a cornerstone of central bank best practices for years, the move on Wednesday was timely because it could help quell nagging doubts that the Fed's unprecedented easy money policies are setting the stage for a nasty bout of inflation.

The U.S. economy strengthened toward the end of last year, with the unemployment rate dropping to a near three-year low of 8.5 percent. If the rebound falters, the inflation target could help pave the way to more bond buying.

"I think this is a dovish move showing the Fed is concerned about deflation and is willing to target somewhat more inflation," said Eric Stein, portfolio manager at Eaton Vance in Boston, who characterized the inflation target as "a big deal."

Already, the Fed gives regular quarterly projections for inflation, widely seen as the informal target. It also gives quarterly projections for unemployment.

In the inflation projection given Wednesday, the Fed suggested prices were now rising at a pace consistent with policymakers' goals. As well, estimates of officials on the Fed's policy-setting panel had a central tendency of 5.2 percent to 6.0 percent for the long-run normal rate of unemployment, higher than prior years.

The Fed will reaffirm and "make adjustments as appropriate" to the long-term goals statement each January, it said.

The statement was released simultaneously with another first for the Fed: published charts of individual policymakers' projections for the appropriate path of the benchmark federal funds rate.

(Reporting by Jonathan Spicer; Additional reporting by Ann Saphir and Karen Brettell; Editing by Padraic Cassidy and Leslie Adler)

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