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Inflation views could change under Bernanke Fed

Rachel Beck

NEW YORK – Trying to fix something that isn’t broken has its risks, and that’s raising concerns about a possible shift at the Federal Reserve over how it tackles inflation.Assuming the Senate confirms Ben Bernanke to replace Chairman Alan Greenspan, the central bank could for the first time in its history adopt a specific target for the inflation rate and then make adjustments to interest rates as a way of trying to keep it in that range.But is that really necessary? It may be tough to see the need now, given that the Fed’s current tactics have kept inflation remarkably tame despite soaring energy costs.This topic has come under great debate in economics circles since Bernanke was tapped last month to succeed Greenspan, who is expected to leave the Fed on Jan. 31 after 18-plus years during which there were two stock-market collapses and economic recessions as well as numerous other financial crises.While Greenspan has long pursued a low-inflation policy during his tenure, he has been against setting an actual “inflation target,” whereby the Fed discloses its goal and its forecast for inflation. His view is that the Fed can control inflation without setting a specific rate that it must then chase, which he believes could hamper its flexibility to act in a time of need.That stance has proven successful time and again, including in the last year as energy prices have skyrocketed but the core inflation rate – as measured by the consumer price index excluding energy and food costs – has remained at only around 2 percent, low by most standards.The Fed has done that by raising the rate that banks charge each other on overnight loans, known as the federal funds rate, in 12 quarter-point increments so that it now stands at 4 percent. The Fed began its current credit tightening cycle in June 2004 when the funds rate stood at a 46-year low of 1 percent.Like Greenspan, Bernanke – a former Fed governor who now serves as President Bush’s top economic adviser – favors low inflation, but he wants to be more forthcoming and open about what that actually means.He has argued in the past that by setting an inflation target, it will lead to a more stable economic environment because businesses and consumers would be more certain about how the Fed will deal with interest rates and inflation. Bernanke has also said that in times of financial crises, the Fed could depart from its normal rules to do whatever it can to stabilize the economy.Supporters say such change would raise the Fed’s accountability and limit the discretion of future Fed leaders. In addition, they point to the successes abroad, with many countries including Australia and Sweden as well as the European Central Bank now employing some inflation targeting.”The Fed has gained a lot of credibility under Greenspan’s tenure, and all Bernanke is saying is that we can reinforce that by setting an inflation target,” said Lyle Gramley, a former Fed governor in the early 1980s who now is a senior economic adviser at Stanford Washington Research Group. “This will make it explicit to the public what the Fed’s expectations are.”Still, there are many questions over whether there is any need for such a change, something that will likely be addressed during his confirmation hearing before the Senate Banking Committee on Nov. 15.One issue is whether “Bernanke would want to target a growth range on inflation, not a specific price index level, because a miss in the target could prove extremely punishing on the economy,” Merrill Lynch economist Kathleen Bostjancic said in a note to clients.For instance, she notes, if the Fed’s target for core CPI is 2 percent for the year, but actual inflation comes in at 2.5 percent, then inflation would have to come in well under 2 percent in the following year to meet the target. And getting to that level could require a considerable slowdown in the economy, presumably triggered by the Fed cranking up borrowing costs.Another point is whether an explicit inflation target would actually improve economic performance. Wells Fargo economist Eugenio Aleman says that even without an inflation targeting mechanism, the U.S. economy has had superior economic growth than many countries that implemented inflation targeting.There is also the issue of whether setting an inflation target would subordinate the Fed’s other Congressional mandate to maintain a sustainable level of employment. The worry is that the Fed will become more interested in meeting its inflation goals rather than creating job growth.The good news is that Bernanke is known as a consensus builder. Chances are that he won’t rush to push his agenda, but will work to convince those who are opposed of its merits. That, however, could be a mighty hard task.—Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.orgVail, Colorado


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