US Federal Reserve moves a step closer to formal inflation target

Bernanke says he will deliver price stability

The Federal Reserve, the US central bank, moved a significant step closer to setting a formal inflation target yesterday, saying that it expected the cost of living to rise at between 1.7 per cent and 2 per cent over the long term.

The Fed chairman Ben Bernanke, a long-time advocate of inflation targeting, said that the range is one “that promotes maximum sustainable employment while also delivering reasonable price stability”, according to a broad consensus on the Fed’s interest rate-setting Federal Open Market Committee.

“Increased clarity about the FOMC’s views regarding longer-term inflation should help to better stabilise the public’s inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low,” Mr Bernanke said in a speech to the National Press Club.

The FOMC set its long-term expectations for US unemployment and GDP growth as it published the minutes to its January meeting yesterday, part of an effort that Mr Bernanke claimed would bring more transparency to its deliberations. GDP growth is expected to trend towards a 2.5-2.7 per cent annual rate, with unemployment at 4.8-5.0 per cent, according to the minutes.

The ranges are not formal targets, Mr Bernanke insisted, but do reflect what the committee believes is the “sustainable” rate of growth and inflation in the US, “under the assumptions of appropriate monetary policy and the absence of new shocks to the economy”.

The idea of anchoring the public’s inflation expectations has moved up the agenda over the past year, as cost of living rises soared to multi-decade highs on the back of high fuel prices, only to crash to such as an extent that deflation is now a real worry for policymakers.

At its January meeting, the FOMC held its target interest rate at near-zero and again restated its intention to use extraordinary interventions in the credit markets to reduce the real cost of borrowing for consumers and businesses.

While such interventions are aimed at preventing the US from heading into a deflationary spiral, Mr Bernanke was at pains yesterday to ease the |fears of conservatives who worry that, in the medium-term, they risk igniting a new round of inflation. The dramatic expansion of the Fed’s balance sheet, which is now being used to lend almost $2 trillion into the credit markets, could be easily reversed, the chairman said.

“The Fed’s lending activities have indeed resulted in a large increase in the reserves held by banks and thus in the narrowest definition of the money supply. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates have been much lower,” he said.

“With global economic activity weak and commodity prices at low levels, we see little risk of unacceptably high inflation in the near term. Indeed, we expect inflation to be quite low for some time.”