The San Francisco Fed president would let prices grow faster—sometimes.
By Peter Coy, Bloomberg
The Federal Reserve would never get a medal in archery. Since January 2012, when it publicly adopted a target of 2 percent for annual inflation, it has undershot in 59 of 63 months. John Williams, president of the Federal Reserve Bank of San Francisco, believes there’s a way to help the institution improve its aim.
The Fed would still try to keep prices rising at 2 percent a year, but if it fell short one year, it wouldn't just try harder to hit 2 percent the next year, as it does now. Instead, it would try to jack inflation above 2 percent temporarily to get back on track. The Fed would be like the driver of a car who makes up for getting stuck in traffic by speeding up—or slows down when she realizes she’s gotten ahead of her intended pace.
Williams laid out the justification for what he calls “flexible price-level targeting” in a speech in New York on May 5 to a group called the Shadow Open Market Committee, an independent group of economists that comments on Federal Reserve policy. In a phone interview on May 27 he explained why he thinks that now is the right time for an idea he concedes has been around for a while.
If price-level targeting caught on, businesspeople and consumers would be able to predict with confidence how high prices would be in 10, 20, or even 30 years. That’s hard for the Fed to promise in the current era of sluggish growth, one in which both interest rates and inflation have tended to come in lower than expected. “Arguments for price-level targeting are just much more powerful now than 20 years ago,” Williams says. Another reason the time is ripe, Williams says, is that the economy is close to full employment, so the Fed can afford to make big policy changes. Says Williams: “We’re not right in the middle of battle.”
He isn’t advocating that the Fed try to make up for years of below-target inflation rates. (To do that, prices would have to rise 3.9 percent in one swoop.) Instead, he advocates starting fresh with a new target. In his speech, he argued that there’s nothing inherently hawkish or dovish about price-level targeting. True, in recent years it would have led to a more dovish policy (i.e., easier money), but if practiced in the 1960s, it would have led to a hawkish policy that cooled economic growth to extinguish inflation, Williams said.
Williams won’t reveal whether any of his fellow members of the rate-setting Federal Open Market Committee have been swayed by his argument, but he says that he’s hopeful: “Central banking is one of those areas of policy where ideas matter.”
Williams’ paper was well received by the Shadow Open Market Committee, which tends to be hawkish, says Charles Calomiris, an economist at Columbia Business School who is a member. Calomiris advocates increasing rates more quickly than Williams does. But he agrees that there’s nothing necessarily dovish about targeting the price level: “The idea of keeping track of your cumulative hits or misses rather than your moment to moment hits or misses has a lot of attraction.”
Maybe the Fed could wind up with a medal in archery after all.