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Will Fed announce an inflation target?

By Holden Lewis ·
Wednesday, October 13, 2010
Posted: 9 am ET

Yesterday I outlined the disagreement within the Fed about the causes of high unemployment. Members of the rate-setting committee also seem to have differing views about inflation targeting.

Observers believe that the Fed wants inflation between 1.5 percent and 2 percent. If inflation is below that, consumers are reluctant to spend, and if inflation is higher than that, consumers and businesses don't know where to save and invest.

The Fed doesn't set an explicit inflation target. It's implicit and mostly unspoken. This policy gives the Fed more flexibility. The downside of flexibility is uncertainty. Employers and investors have to guess about the level of inflation that the Fed wants.

"Participants noted a number of possible strategies for affecting short-term inflation expectations," say the Fed's minutes from Sept. 21, "including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP."

So the Fed is mulling several options. It could publicly state a short-term inflation target. Or, because inflation is low this year, the central bank could let the inflation rate rise artificially high next year to let prices "catch up" to where they would have been if inflation had been at the optimal level all along.

Whether or not the Fed sets an explicit inflation target, it seems clear that the central bank is leaning toward opening the money spigots again when the rate-setting committee meets Nov. 2 and 3. The goal would be to push long-term interest rates even lower.

There's no guarantee that mortgage rates would fall appreciably, though. And lenders aren't about to loosen their lending standards, not when regulators and attorneys general are spanking them over sloppy foreclosure procedures.

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