WASHINGTON (Reuters) - The Federal Reserve’s willingness to accept higher inflation is not an effort to “make up” for weak price increases in recent years, but to ensure its 2 percent target is viewed credibly, San Francisco Fed President John Williams said on Friday.
After years of seeing inflation run below its target, the U.S. central bank wants to avoid any slippage in expectations, which would pose a risk to the economy and make it harder for the Fed to reach its goal, Williams said during an event at the Brookings Institution.
“We want inflation to move back to 2 percent and stay around 2 percent, knowing that in any given year it will fluctuate up and down,” Williams said.
While the Fed said in its policy statement last week that the inflation goal is “symmetric,” a phrase officials acknowledge may mean periods of inflation above 2 percent, Williams explained that should not be read as “a forceful attempt to make up for lost inflation in the past.”
Unless inflation stays around 2 percent on average, “there is a risk that people start thinking the Fed, ‘well they say 2 percent but they are really going for one and a half.’ And then you miss on that, there is a fear it deteriorates further,” he said.
His comments add to the understanding of what a “symmetric” inflation target means - more a rough guide than any explicit promise to offset past inflation losses with future inflation gains.
Williams spoke on Friday as part of a discussion of Fed staff research that advocated the central bank explicitly aim for much higher inflation during good times to compensate for the low interest rates and weak wage and price growth associated with downturns.
The paper by Fed economists Michael Kiley and John Roberts foresees an extended period ahead when the central bank may have to cut rates to zero during even modest recessions. They argue that by boosting inflation and rates higher during the recovery, those trips to the “lower bound” may be made less frequent and less damaging.
Their approach, or one of a number of similar policy strategies, is something that Williams personally favors as a way to allow the Fed’s short-term real policy rate to move higher. In setting policy, the Fed looks at “real rates” - its stated nominal rate less inflation - so higher inflation allows a higher nominal rate, all things being equal.
But he said a shift in that direction would have to be carefully communicated to the public, and could not be developed “on the fly.”
Reporting by Howard Schneider; Editing by Paul Simao