The minutes from the Federal Reserve’s October meeting reflect the challenges that the Committee faces with regard to normalizing policy in an environment of low inflation expectations. According to Fed participants, who noted that “inflation was continuing to run below the Committee's longer-run objective…[while] market-based measures of inflation compensation [had] declined somewhat…a few expressed concern that inflation might persist below the Committee's objective for quite some time.” Accordingly, it is not surprising that many participants suggested that the Committee remain attentive to “evidence of a possible downward shift in longer-term inflation expectations; some of [whom] noted that if such an outcome occurred, it would be even more worrisome if growth faltered.”
Even though the public statement made at the conclusion of the October meeting included the phrase that the Committee judged “the likelihood of inflation running persistently below 2 percent [had] diminished somewhat since early this year”—the same phrase that was included in the July and September statements—it’s hard to reconcile this comment with the behavior of both survey- and market-based inflation assessments (Chart 1), which have shown a sharp decline over the past several months.
Chart 1: Market-Based and Survey Measures of Future Inflation
Indeed, concern over the recent decline in inflation expectations led Minneapolis Fed voting member Kocherlakota to disagree with his colleagues over the text of the Fed’s post-meeting statement.
“Mr. Kocherlakota dissented because he believed that, in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to maintaining the current target range for the federal funds rate at least until projected inflation one to two years ahead has returned to 2 percent and should continue the asset purchase program at its current pace. Mr. Kocherlakota noted that when the Committee first reduced its asset purchases in December 2013, it said in the post-meeting statement that it would be monitoring inflation developments carefully for evidence that inflation was moving back toward its objective over the medium term; Mr. Kocherlakota indicated he saw no such evidence.”
The Committee also discussed whether the Statement on Longer-Run Goals and Monetary Policy Strategy warranted any changes before it was reaffirmed in January 2015. Part of the strategy reads:
“In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.”
While the Committee judged that inflation “moderately above the Committee's 2 percent goal and inflation the same amount below that level were equally costly”—a view many participants thought was shared by the public—the question was raised whether additional information should be provided about the "balanced approach" that the Committee takes in promoting its two objectives (maximum employment and price stability), particularly “under circumstances in which these objectives are judged not to be complementary.” With the employment picture strengthening (“there had been a substantial improvement in the outlook for the labor market” since the beginning of the Fed’s just-concluded asset purchase program), the Fed’s main challenge will be preventing inflation from declining too far below its target 2 percent rate, especially when disinflation appears to be a non-trivial global threat (Table 1).
Table 1: Global Inflation Rates, Annual Measure
*Core inflation excludes food and energy in the US. In the UK and Eurozone, core inflation excludes energy, food, alcohol and tobacco, while in Japan, core inflation excludes fresh food.
**1.0% after excluding the impact of the April consumption tax hike—i.e., the tax increase was responsible for two percentage points of the annual increase in core inflation.