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Retiring Chicago Fed President Sees Path for Slower Pace of Rate Rises -- WSJ -3-

The Wall Street Journal · 01/06/2023 17:49

That was a strategy that served the FOMC, the Fed, and Chairman Greenspan really quite well during Greenspan's tenure that began in '87. Volcker left the Fed and he broke the back of double-digit inflation, but it was 4% when he left and then it went up in the late '80s, when Greenspan and the Fed had to increase the funds rate to almost 10%. And the answer for quite a long time -- until you get to about '98 or so -- is where should inflation be? The answer's lower. It should be lower, lower than 4%, lower than 3.5%. You didn't have to say we're headed for 2%. We just wanted to be lower. But then you got to the point in the late '90s -- you know, in 2003, around the Iraq invasion, that's when all of a sudden the Fed said, 'Oh, there's a small probability that inflation could be uncomfortably low.' And that was sort of like the, 'Oh, there's downside risk to inflation.' It was under 2% or forecast to be under 2%.

It's always been a worthy objective to be explicit about what you mean by price stability. The choice of the objective has more important implications that many realized in the '80s and '90s because the effective lower bound reared its ugly head in places. And then we've learned that when you hit zero on the policy rate, you can go negative. The European Central Bank and other banks have done that, but they never went very negative. And back in 2008, if you're looking at a Taylor rule for what the Fed should have done during a horrible recession with 10% unemployment, we needed minus-4% on the funds rate, which we could never do. So if you had a slightly higher inflation objective, then you'd have a little more capacity to lower the funds rate during normal times. But it ends up just being a very controversial, very difficult conversation, and I'm not optimistic at all that central banks are actually going to actually debate in a way that might change the inflation objective.

I mean, I think that if the choice had been for a 3% inflation objective and you hit 3% -- I mean, just steady 3% -- you know, then wages would increase yearly on average in line with that and pricing would be reasonable in line with -- it's the variability around inflation like we have experienced in the last two years that is just the really crushing, has a crushing effect on households and businesses and everyone. So having an inflation objective that steadies inflation performance, that's very valuable. The level -- you know, 2% is a very challenging inflation target, it seems to me, during downturns, but it has been a very positive development. And when you marry that with the willingness to overshoot 2% when it's necessary, when it's needed, when it's beneficial, then I think it's more manageable than I might have thought some years ago.

WSJ: Do you think the Fed should consider raising the target to 3%?

MR. EVANS: Well, I mean just as an intellectual exercise, I think it's worthy of thinking that one through. But as I was kind of indicating, I think that the actual -- you know, explaining that, the benefits, I think it would be very difficult and controversial. I expect that 2% is going to be the inflation objective for the foreseeable future.

WSJ: Do you think that the reaction function should change once you get -- assuming the Fed gets inflation down to 3% in some reasonable time -- you look at forecasts, a number of your colleagues had inflation coming down to 3% percent or lower by the end of this year. How do you think the tradeoff should change? Obviously, you risk a recession to get it from 5% or 6% down to somewhere lower. But once you're at 3%, should the strategy of opportunistic disinflation come back into how policy is being considered?

MR. EVANS: It's going to depend on the circumstances. The way you describe it, it sounds like it would be a little bit challenging. At the moment we're seeing improvements in goods inflation, but we're nervous about service inflation. Service inflation's likely to be stickier and harder to come down. Even if overall core PCE comes down, I wonder -- I do not know the answer about the committee's attitude about core PCE inflation that is under 2.5%, but not at 2% and with somewhat stronger services inflation than they think is consistent with 2% inflation. I think it's going to depend a lot on where inflation expectations are. Is it the case that markets and the public are feeling good about the central bank's ability to deliver on their 2% inflation rate?

I think in that environment you could reasonably do the opportunistic approach to disinflation. But I think there's going to be nervousness about how long inflation is above target. I think those are going to be lines for debate. And the data are going to make it more difficult or maybe a little easier. I don't know the answer. That'll be a very interesting thing to be paying attention to over the next six months, and perhaps much longer.

Write to Nick Timiraos at Nick.Timiraos@wsj.com

(END) Dow Jones Newswires

January 06, 2023 17:49 ET (22:49 GMT)

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