(Reuters) - An influential Federal Reserve policymaker appears to want the Fed to adopt wholesale changes to the way it targets inflation, urging a new framework that would encourage higher prices and provide more flexibility in U.S. economic downturns.
New York Fed President John Williams did not comment on current interest-rate policy on Friday. Instead he waded into a debate that has just began: the U.S. central bank announced in November it will conduct an extensive review of its policy strategy and consider alternative approaches.
Williams, who has long favored changes, said the Fed faces “significant challenges” in a world in which so-called neutral, or equilibrium, interest rates have been falling for years in part because people live longer and productivity has generally slipped.
The Fed currently uses a flexible inflation-targeting strategy in which it always attempts to hit a 2-percent target. Prices are generally at target now and they did not stray too far below or above even through the last recession and recovery.
Yet inflation expectations could slip if the Fed is repeatedly forced to cut rates to near zero as it did for seven years. Williams said this was like “always swimming upstream, fighting a current of too-low inflation expectations that interferes with achieving the target inflation rate.”
Instead he highlighted the benefits of “average-inflation” and “price-level” regimes, similar approaches which would compel the Fed to boost prices to make up for periods below target.
“Neither will likely be effective in practice unless communicated clearly and carried out consistently over time,” he said at a meeting of Group of Thirty central bank officials at the Federal Reserve Bank of New York.
The Fed, under pressure from a critical White House, is taking advantage of good economic times to host a series of forums across the country next year to hear from a “wide range” of stakeholders. By mid-2019, it could lead to a rethink of the tools it uses and the way it communicates policy decisions.
At the center of the debate will be whether the Fed should continue to rely on large-scale asset purchases, or quantitative easing, in times of crisis - or rather should it adjust the inflation framework so that using QE is less likely.
For his part, Williams said that maintaining the status quo “carries with it the risk that inflation expectations become anchored at too low a level.”
Reporting by Jonathan Spicer; Editing by Chizu Nomiyama