Evans: ‘Appropriate’ to boost inflation temporarily

By Reuters
Posted Oct. 19, 2010 at 9:58 a.m.

The U.S. Federal Reserve should pump more cash into the economy and temporarily stoke inflation to counter the stifling effects of high unemployment and undesirably low inflation, a top Fed official said on Tuesday.

“For many, my proposal will be a hard pill to swallow,” Chicago Fed President Charles Evans told a group of business leaders in Evanston.

Historically the U.S. central bank has sought to fight, not feed, inflation.

But the U.S. economic recovery slowed this summer, leaving little chance that unemployment, now at 9.6 percent, will fall below 8 percent by 2012, said Evans, who will rotate into a voting spot on the Fed’s policy-setting committee next year. Meanwhile, inflation is running below the 2 percent pace the Fed sees as optimal, and looks like it may be stuck there through 2013, he said.

Evans, whose recent statements have put him on the dovish end of the Fed’s spectrum, repeated his view that the United States is likely in a liquidity trap, in which cautious households and businesses save rather than spend, despite low interest rates.

“Economic theory tells us that in such circumstances monetary policy should aim to lower the real, or inflation-adjusted, rate of interest by temporarily allowing inflation to rise above its long-run path,” Evans said. “In my opinion, such a strategy is entirely appropriate.”

The central bank, which has already pushed U.S. short-term interest rates to near zero and has bought $1.7 trillion in mortgage-backed securities and Treasuries to support the economy, is widely expected to undertake a fresh round of Treasury purchases next month in a bid to inject new energy into the recovery.

Evans, repeating a view he has expressed on several occasions recently, said he supported such a move.

“The magnitude of resource slack, combined with the fact that inflation has been running below the level I consider consistent with long-term price stability, suggests to me that it would be desirable to increase monetary policy accommodation,” Evans said.

In advocating a temporary increase in inflation, or so-called price-level targeting, Evans on Tuesday described a process that dovetails with the Fed’s expected new round of Treasury purchases.

A short-term increase in inflation would offset the current period of low inflation, putting long-term inflation closer in line with the Fed’s target, he said.

“Practically speaking, price-level targeting in the current environment would call for a series of large-scale asset purchases to recover the shortfall in inflation,” Evans said. “At the same time, we would continue to carry a large balance sheet in order to maintain low interest rates for an extended period. Most important, we would clearly communicate the path for prices that we expect to attain, in order to enhance the public’s understanding of the Fed’s intentions.”

Evans said the strategy needs more study, and that the Fed would need to plan in advance how to rein inflation back in if needed, using tools it has developed to drain excess reserves from the banking system.

It’s unclear how much support such a strategy has, although it has been mentioned recently by several other top Fed officials, including New York Fed President William Dudley and Minneapolis Fed President Narayana Kocherlakota.


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