A top U.S. central banker on Thursday floated the possibility of increasing the Federal Reserve's inflation target as a way to reduce financial stability risks and make it easier for the Fed to achieve price stability and full employment.
Minneapolis Fed President Narayana Kocherlakota, speaking at the Bank of Korea in Seoul, stopped short of advocating the move, saying that the Fed would need to weigh the benefits against costs including a possible hit to Fed credibility if it is seen as simply moving its own goal posts.
But the comments show Kocherlakota continues to marshal new arguments for keeping interest rates low even as most of his colleagues see the time for a rate increase as approaching. Another dovish Fed policymaker, Boston Fed chief Eric Rosengren, has also recently raised the notion of boosting the Fed's inflation target.
Most of Kocherlakota's speech Thursday reprised remarks made in Frankfurt last month in which he argued that a drop in the long-run interest-rate level consistent with full employment and stable prices is making the Fed's job harder.
But on Thursday he also warned that the decline in the so-called long-run neutral real interest rate also imperils financial stability, because it forces the Fed to keep rates lower for longer in order to achieve its goals, increasing the likelihood that investors will make risky trades to boost their returns.
Raising the Fed's inflation target could mitigate those problems by lifting the longer-run fed funds rate.
"This would offset the impact of a decline in the long-run neutral real rate of interest by giving the (Fed) more 'policy space' to respond to adverse shocks," Kocherlakota said.
Kocherlakota, who will leave the Fed at the end of the year to return to academia, has for years tried to convince his colleagues that the Fed needs to hold interest rates near zero until well into 2016. Doing so, he has said, would help boost inflation, now well below the Fed's 2-percent target, back to healthier levels.
Many Fed officials, however, are becoming convinced that the economy is getting strong enough to withstand a rate hike in coming months.
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