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7/29/2020 News release: Should the Fed Target Prices or Inflation? For release:Oct. 19, 1999 Contact: Charles B. Henderson, (314) 444-8311 Should the Fed Target Prices or Inflation? ST. LOUIS, Mo. -- If the Federal Open Market Committee (FOMC) - the policymaking body of the Federal Reserve - adopted a long-term objective for the price level, uncertainty about future inflation would be greatly reduced. That perspective comes from Robert Dittmar, a mathematician, and William T. Gavin, a vice president and research coordinator, both with the Federal Reserve Bank of St. Louis, and Finn E. Kydland, a professor of economics at Carnegie Mellon University. Their research and comments appear in the latest issue of Review, the St. Louis Fed's bimonthly journal of business and economic issues. At least eight central banks around the world have now adopted explicit targets for inflation. In all of these cases, the policy process focuses on inflation, but weighs other variables such as employment, the growth of GDP, and the behavior of a short-run policy guide such as the federal funds rate or an exchange rate. Because the countries consider many such variables and, in essence, have multiple goals, Dittmar, Gavin and Kydland found that considerable uncertainty exists about future prices. One remedy for this uncertainty is to look only at inflation and ignore the consequences for employment and the business cycle. The authors, however, propose a more palatable solution: Add a long-term price-level objective to a short-run inflation targeting process, which may reduce the long-run uncertainty about prices without giving up concern for other things. "With a long-term price-level objective, you have increased short-run flexibility," said Gavin. "You can accommodate temporary price shocks or ease policy in response to financial crises and recessions without raising fears of higher inflation in the long run. In effect, the long-term price-level objective can be achieved with a very small correction in the short run because, by definition, we have a long time to get there. If the long-run goal is credible, private sector expectations will have a stabilizing effect on inflation and the economy. Operating through people's expectations of future inflation, this stabilizing effect gives policymakers some wiggle room in the short term." Under their proposal, the FOMC would decide on a long-term (four or five years) objective for inflation. The FOMC report to Congress would include a multi-year path for the chosen index growing at the desired inflation rate, as well as annual targets for money and credit. The Open Market Desk at the New York Fed would continue to operate on a daily basis as it does now, buying and selling Treasury debt to maintain a target for the federal funds rate. "The minor, but important, difference would occur at FOMC meetings," said Gavin, "where policymakers would monitor the price level in relation to its long-term objective. At every FOMC meeting, there would be some members who would support a policy decision to encourage the price level to return to its long-run target range. We believe that the very existence of a public commitment would give those members' opinions more clout in the final vote." Subscriptions to Revieware free and can be obtained by calling (314) 444-8809. The publication is also available on the Federal Reserve Bank of St. Louis' Web site: www.stls.frb.org. https://web.archive.org/web/20000930071053/http://www.stls.frb.org/general/releases/rel99/nr1019.html 1/2 7/29/2020 News release: Should the Fed Target Prices or Inflation? With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. In addition to serving as a bank for depository institutions and the U.S. government, each Reserve Bank monitors economic conditions in the District, participates in formulating monetary policy, and supervises state-chartered member banks and bank holding companies to foster safety and soundness of the District's banking and financial institutions and protect the credit rights of consumers. https://web.archive.org/web/20000930071053/http://www.stls.frb.org/general/releases/rel99/nr1019.html 2/2
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