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Federal Reserve officials have been bemoaning the state of low inflation. One central bank official believes it's actually the Fed's own fault.
Minneapolis Fed President Neel Kashkari contends in an analysis posted Monday that the Fed has driven down inflation expectations by tightening policy sooner than it should. Central bank officials have indicated a desire to raise interest rates on a slow but regular basis, even though most acknowledge that inflation remains below the Fed's 2 percent target.
The Fed believes 2 percent is a healthy rate to keep the economy at a sustainable growth pace. While inflation often is considered a negative, too low a rate usually points to a weak economy and slow wage growth.
The personal consumption expenditures index, which is the Fed's main inflation gauge, remains stuck around 1.3 percent annualized, and in fact has been dropping this year.
Kashkari, though, has been one of the few overtly dovish officials on the Federal Open Market Committee, disagreeing with the majority's view that it should keep hiking to stave off future bursts in inflation and to provide some ammunition to use in case of an economic downturn.
"My preference would be not to raise rates again until we actually hit 2 percent core PCE inflation on a 12-month basis, unless we have seen a large drop in the headline unemployment rate signaling that we have used up remaining labor market slack, or a surprise increase in inflation expectations," Kashkari wrote on Medium.com.
In an effort to spur growth during the financial crisis, the FOMC took its benchmark funds rate to near zero in late 2008, then kept it there for seven more years. Since then, the Fed has hiked the rate four times to the current range of 1 percent to 1.25 percent.
In addition to keeping rates low, the Fed initiated three rounds of bond buying that boosted its balance sheet to $4.5 trillion, a process that it will start unwinding later this month.
According to the most recent projections, released in September, the committee figures there to be seven more hikes between now and the end of 2019, bringing the funds rate to about 2.8 percent.
Sending up that flare has tamped down inflation expectations as markets view the Fed preferring pre-emptive hikes rather than waiting for inflation to hits target, Kashkari argued.
"We know that monetary policy operates with a lag. I believe these actions to remove various forms of accommodation are now having an effect on the economy by lowering inflation expectations," he said.
"In my view, inflation expectations declined because actual inflation was below target for a long time, and the Fed's actions to reduce accommodation led to a weakening of confidence that it was serious about bringing inflation back to target in a reasonable time frame," Kashkari added.
Fed Chair Janet Yellen and others at the central bank have argued that inflation is low due to transitory factors like declines in cellphone plan pricing. However, Kashkari said inflation has remained low globally due to central banks collectively following similar practices.
"The only explanation that would potentially call for further policy tightening is the transitory factor explanation. But the longer low inflation persists (here and around the world), the more tenuous that story becomes," he said.
"Allowing inflation expectations to slip further will mean that we will have less powerful tools to respond to a future economic downturn. I believe these are significant costs that we must consider as we contemplate the future path of policy."