Ladies and Gentlemen, We Have Explicit Fed Targets

Today, the Federal Reserve announced that it will keep its foot on the easy-money pedal until the unemployment rate drops below 6.5% or inflation looks to go above 2.5%. The proposal has been getting some press as of late (you can see my recent post after Fed Vice Chair Yellen brought up the idea in November). This is almost exactly what Chicago Fed president Charles Evans proposed back in 2011. Well, Evans has evidently convinced everyone else at the Fed. Well, not everyone…Jeffrey Lacker dissented again (I’ve mentioned Lacker before too).

What we’ve got now is a shift in policy communications. The Fed has dropped its time-based estimates (e.g., “at least through mid-2015”) in favor of explicit targets tied to the two factors of its dual mandate: maximum employment and price stability.

This change in communications style is an attempt to let people’s expectations of Fed policy adjust with changes in the economy. This also lets the market know that the Fed is willing to tolerate a bit of short-run inflation while the unemployment rate works its way down.

  • Anonymous

    Excuse me while I be a bit Homo economicus dubiī, But if inflation goes above 2.5% and one of the explicit targets is “price stability.” Would this mean that stagflation would likely be one of the results?

    • Robin Anderson, Economist, Principal Global Investors

      Thanks for reading and thanks for the comment! Sorry about the delayed response…holidays and everything. Stagflation is higher inflation coupled with stagnant growth like in the 1970s; you’ve got that exactly right. But we don’t see that sort of environment returning anytime soon. Actually, we believe that the underlying fundamentals of the U.S. economy are better than is commonly realized: housing is clearly better; consumer confidence has been coming back; retail sales are persistently good; the drag from state and local government layoffs and budget cuts is over. So, absent serious problems over the fiscal cliff, the economy should return to 2.5% to 3% growth. The Fed’s current intention is to not worry so much about a small pickup in inflation; but we think that would be accompanied by faster growth. The question for Homo economicus dubiī (the doubtful economic human) is whether current Fed policy will lead to higher inflation than the Fed could tolerate; and that could happen, but likely not very soon.