By Steve Matthews
Feb. 19 (Bloomberg) -- Federal Reserve policy makers signaled their determination to prevent any spiraling of inflation as a consequence of unprecedented U.S. fiscal stimulus and record growth in the central bank’s balance sheet.
Fed officials introduced long-term inflation projections yesterday, with most favoring a 2 percent rate. The forecasts will help moor the public’s expectations, Chairman Ben S. Bernanke said.
The step shows that Fed officials are intent on fulfilling their mandate to ensure price stability after the stock of money known as the monetary base soared 80 percent in the past six months. With long-term inflation expectations in household surveys hovering at 3 percent in that period, the surge in cash could threaten to send up bond yields, hindering efforts to generate an economic recovery by year-end.
“They are trying very hard to anchor inflation expectations,” said Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut and a former Fed economist. With a credible objective, that may help people “have confidence the Fed will bring inflation into line.”
The inflation forecast, revealed yesterday in minutes of the Jan. 27-28 Federal Open Market Committee meeting, moves the Fed closer to adopting a formal inflation objective, a goal central banks in the euro region, the U.K. and other countries must observe in crafting interest-rate policies.
Record Stimulus
The Fed’s move came a day after President Barack Obama signed a $787 billion stimulus bill into law. It also followed an expansion of the central bank’s assets to $1.8 trillion from $959 billion during the past year.
“Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve will ultimately stoke inflation,” Bernanke said yesterday at the National Press Club in Washington.
The inflation forecast “should provide the public a clearer picture of FOMC participants’ policy strategy for promoting maximum employment and price stability over time,” he said. It should also “help to better stabilize the public’s inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low.”
The introduction of longer-term forecasts for inflation, unemployment and economic growth is part of Bernanke’s campaign to make the Fed more transparent in policymaking. He said the projections would represent Fed board governors’ and district- bank presidents’ projections over a period of five to six years.
Communicating to Markets
“They view this as an improvement in communications and a desire to communicate their objectives to the market,” said Robert Eisenbeis, a former research director at the Atlanta Fed and chief monetary economist at Cumberland Advisors Inc. in Vineland, New Jersey.
“If you react late to inflation pressures building, you will lose credibility to inflation expectations at your long-run target,” he said. “By the time inflation goes over 2 percent, it’s too late because of lags in policy.”
The Fed’s current policy of purchasing more assets and pumping money into the financial system won’t stoke a rise in prices, Bernanke said. Most banks are leaving the “great bulk” of excess reserves idle, primarily by keeping the funds on deposit with the Fed, he said.
“We expect inflation to be quite low for some time,” Bernanke said in the speech.
A minority of U.S. central bankers estimated long-term inflation at 1.5 percent or 1.75 percent, according to the forecasts released yesterday alongside the FOMC minutes.
‘Inflation Back’
“We will get inflation back in the out years,” said Gregory Miller, chief economist at SunTrust Banks Inc. in Atlanta. He predicts inflation will rise next year to 3.8 percent from a 0.1 percent decline in the 12 months to January, according to the median forecast in a Bloomberg News survey.
The monetary base, the total money in circulation plus reserve deposits at central banks, has grown to $1.5 trillion from $843 billion in October, according to Bloomberg data.
“I suspect the Fed would choose to err on the inflationary side, at least in the short run, and accept a bit of inflation above their stated targets,” Miller said. “They will risk leaving the policy rate too low for too long and let inflation move higher.”
Two measures of inflation expectations show both consumers and investors are looking for inflation to pick up over the longer term. Public expectations for inflation have risen since late December from the lowest level in more than six years, according to a Reuters/University of Michigan survey.
Investor expectations for inflation have increased since late December from the lowest level in more than a decade, according to the difference in yield between nominal Treasuries and 10-year Treasury Inflation Protected Securities.
Explicit Target
While Bernanke favored an explicit target for inflation in the past and co-wrote a book on the subject, he has noted the political difficulty of instituting one for the Fed.
Bernanke pledged to Congress in his 2005 nomination hearing that he would take no “precipitate steps” toward such a move. Instead, he highlighted officials’ third year of predictions as a signal for their policy objectives.
Other Fed officials have continued to advocate an inflation target, including Chicago Fed President Charles Evans and Philadelphia Fed President Charles Plosser.
To contact the reporters on this story: Steve Matthews in Atlanta at smatthews@bloomberg.net
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