Kocherlakota Explains His Dissent

October 31st, 2014 5:07 pm | by John Jansen |

Federal Reserve Bank of Minneapolis President Kocherlakota explained his dissent at this week’s FOMC meeting. He thinks that the Fed is risking its credibility on the inflation issue and suggests that Europe and the US are traveling down the same path which took Japan into years of deflation.

Via the FT:

October 31, 2014 5:30 pm

Fed risks credibility, says official

The US Federal Reserve risks making the same mistake as Japan in the 1990s by letting inflation run below target, warned the president of the Minneapolis Fed as he explained his dissent at this week’s meeting.

With inflation running below the 2 per cent target for a couple of years, Narayana Kocherlakota told the Financial Times it is essential to take “ongoing action” to maintain the credibility of the Fed’s inflation goal.

Mr Kocherlakota’s remarks highlight a problem for all central bankers as inflation falls around the world – convincing the public that they will still hit their price goals. Fear that so-called ‘inflation expectations’ are falling led the Bank of Japan to launch a massive new stimulus on Friday.

Although Mr Kocherlakota was outvoted by 9-1 when the Fed halted its ‘QE3’ asset purchase programme this week, his dissent highlights continued concern within the central bank about sluggish inflation. Prices are up just 1.5 per cent on a year ago.

“You look at what’s happened in Japan, what’s happening right now in Europe – I think we just cannot take the credibility of our targets for granted,” he said.

However, most Fed officials are reasonably confident inflation will return to target now the unemployment rate is down to 5.9 per cent and falling.

Mr Kocherlakota said he is worried by the combination of a long period of low actual inflation and bond markets pricing in lower inflation in the future. “It’s a big ship that requires time to turn,” he said. “The long time we’ve spent below 2 per cent is creating its own momentum.”

A fall in expected inflation could lead to lower wage demands and fewer price rises by companies, creating a downward spiral of further drops in inflation.

“I think it creates a risk to our getting back to 2 per cent eventually, even over a four or five year time horizon. It creates a risk to inflation expectations staying well anchored,” he said. “That starts to feed back on inflation itself.”

“That risks a process we saw in Japan in the 90s – which now the Bank of Japan is struggling to deal with – and some argue we’re now seeing it at work in Europe,” said Mr Kocherlakota. “I look at those experiences and those are eventualities I don’t want to get myself into.”

The Minneapolis Fed president, who has moved sharply from being one of the more hawkish members of the rate-setting Federal Open Market Committee to its biggest dove, said there were at least two things the Fed could have done this week.

One, he said, would have been continuing to buy assets at a pace of $15bn-a-month. “The macroeconomic impact of those purchases is relatively small, but I think the signalling impact would have been very large,” he said.

The other option would have been to signal an intention to keep interest rates at zero until such time as the Fed forecasts inflation getting back to target within a year or two.

The Fed did say it will delay rate rises if progress on inflation is slow, but he said that is not sufficient. “If you have a target, you should show alacrity in pursuing that, unless you can point to costs of having that alacrity,” he said.

Having registered his dissent, as he did in March, Mr Kocherlakota may not vote ‘no’ again in December.

“The fact that I dissented at this meeting does not necessarily mean I will dissent at the next meeting by any means. It will depend on the circumstances at that meeting,” he said.

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