Fed Reviews Inflation Target

Economic Blog

The Federal Reserve (Fed), and central banks globally, have been fretting over low inflation for years, but extraordinary central bank efforts to push inflation higher have not had much success achieving the desired effect, and may have come with unintended consequences.

As shown in the LPL Chart of the Day, core personal consumption expenditure (PCE) inflation, a version of the Fed’s preferred measure of inflation, has only reached the Fed’s 2% inflation target intermittently over the last 10 years.

inflation-has-remained-stubbornly-low

The Fed is looking for a better way to tackle inflation as part of its comprehensive review of its strategies and tools. The minutes from the Fed’s January policy meeting, released February 19, gave us some insight into how discussions have been progressing. The 2% target, first put in place in 2012, is not in question, but the Fed is looking at creating different ranges around the target that would give them more flexibility while retaining the credibility of the target itself.

“We continue to be reassured by Fed Chair Jerome Powell’s pragmatic approach to monetary policy,” said LPL Chief Investment Strategist John Lynch. “We’ve seen central banks struggle with how to tackle persistently low inflation during a period of economic expansion. Re-examining the current approach may help lead to better outcomes with less risk from overreaching.”

WHY WORRY ABOUT LOW INFLATION?

For those of us who may remember waiting in long gas lines in the 70s or 18% mortgage rates in the early 80s, it may sound odd to worry about low inflation, but low inflation can also create risks.

  • It provides little margin of error in avoiding deflation (prices falling), which can be harmful to an economy,
  • It can encourage excessive saving and delayed purchases, which can keep an underperforming economy from getting back on track.
  • It’s a sign that central banks may be able to do more to help the economy with low risk of dangerous inflationary pressure building.
  • It can undermine central banks’ credibility in their ability to maintain their target, which may end up pulling inflation expectations too low.

For more of our investment insights, check out our Outlook 2020: Bringing Markets Into Focus.

 

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