In the latest sign of an upside-down economy, we learned today that inflation is getting too low for the Fed’s comfort.
The Federal Open Market Committee said in its statement Tuesday afternoon that “measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”
That’s the Fed’s first explicit acknowledgment that falling inflation could prompt it to further loosen monetary policy, possibly by buying large quantities of Treasury bonds. The Fed wants to avoid a period of falling prices known as deflation that adds to the burden on already overleveraged households and businesses.
Accordingly, the Fed said in its statement Tuesday that it “is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”
In previous statements, the Fed has said only that it would “employ its policy tools as necessary to promote economic recovery and price stability.”
The remarks come at a time when some economists are complaining that the central bank hasn’t been aggressive enough in easing monetary policy to keep up with falling inflation readings. They argue that as much money as the Fed has already poured into the economy, it needs to do still more to prevent a self-fulfilling cycle of declining prices and slowing economic activity.
“The Fed cannot solve all of our problems, but it can stabilize nominal expectations which would add a lot more certainty to our economic environment,” economist David Beckworth wrote this month at his Macro and Other Market Musings blog.
The Fed has grown more concerned over the second half of this year about falling inflation readings. Tuesday’s statement marks a shift from the Fed’s comment at its August meeting that “measures of underlying inflation have trended lower in recent quarters,” and from June’s comment that “prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower.”
That said, not everyone buys the concern about falling inflation, also known in extreme circumstances as deflation. Producer prices rose at a 3.1% annualized rate in August, for instance.
“Ironically, this comes just at a point when the near-term risk of deflation has diminished,” Paul Dales of Capital Economics writes of the Fed's admission that inflation is too low for its taste. He doubts the Fed will move forward with another round of asset purchases anytime soon.
But Beckworth believes the Fed will have to take more action, and that it will eventually have to concede that inflation expectations are falling. The Fed continued to insist in Tuesday's statement that those are "stable," even though several measures including some published by regional Fed banks (such as the Cleveland Fed, above right) show otherwise.
"I still don't get the idea that long-term inflation expectations are stable," Beckworth said. But with the Fed at least admitting that inflation readings are falling, "It's a step in the right direction."