The Federal Reserve risks Japan-style deflation with its latest decision to move toward raising interest rates, a Fed official said Friday.
Federal Reserve Bank of Minneapolis President Narayana Kocherlakota, one of three dissenting votes from the Fed’s monetary policy announcement Wednesday, issued a statement Friday in which he warned that the Fed’s “failure to respond to weak inflation runs the risk of creating a harmful downward slide in inflation and longer-term inflation expectations of the kind that we have seen in Japan and Europe.”
Kocherlakota said that the risk of inflation persistently running below the Fed’s 2 percent target was “unacceptable,” explaining his “no” vote at the end of the Fed’s monetary policy meeting this week.
The Fed this week dropped the guidance that it would keep short-term interest rates near zero for a “considerable time.” The monetary policy committee said instead that it would be “patient” in moving toward tightening monetary policy, a change in language that suggests the Fed remains on course to lift rates in mid-2015.
That decision came despite certain measures of U.S. inflation falling. The Consumer Price Index fell from 1.7 percent annually to 1.3 percent in November, influenced by the plummeting cost of oil. Longer-term inflation expectations also have fallen steeply in recent weeks to the lowest levels since the financial crisis.
Federal Reserve Chairwoman Janet Yellen acknowledged those factors but expressed confidence that inflation would move back up toward the Fed’s 2 percent goal once the drop in oil prices played out and the labor market continued to heat up. Fed officials’ projections released Wednesday showed inflation rising to as high as 1.9 percent next year, finally hitting 2 percent in 2016.
But Kocherlakota noted that inflation has been running below the Fed’s target for 30 straight months and argued that expecting inflation to remain below target for several years was a problem.
He recommended communicating that the central bank wouldn’t raise interest rates as long as inflation was expected to fall short of the target, and turning to quantitative easing if necessary.
In recent months, inflation in many other advanced economies has slipped to near zero. The Euro zone has flirted with outright deflation and the possibility of a triple-dip recession in recent months. After years of deflation, Japan’s central bank has engaged in an unprecedented program of large-scale bond purchases to raise inflation, but that effort appears to have stalled out this winter.
Kocherlakota, the most outspoken “dove” on the current voting roster of the Fed’s monetary policy committee, is set to lose his vote as he rotates out next year. He has also stated his intention to step down from the Minneapolis branch when his term expires at the end of 2016.
The other two dissenters at this week’s monetary policy committee took the opposite view, namely that the Fed should move more quickly to raise rates and withdraw monetary stimulus. Those two regional bank presidents, Richard Fisher of Dallas and Charles Plosser of Philadelphia, are regarded as monetary policy “hawks.”
