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Greenspan, Alan

Federal Reserve Takes Step Towards Inflation Targeting

Strategic Insights

— 2 min read

The Federal Reserve has taken a significant step towards setting a formal inflation objective, releasing forecasts that indicate it expects inflation to remain between 1 1/2-1 3/4 percent for the next two years. This move suggests increased transparency in monetary policymaking, which will be closely monitored by the markets. The development also points to possible new thinking inside the Fed as the long chairmanship of Alan Greenspan draws to an end.

Key Takeaways:

  • The Federal Reserve has released forecasts indicating it expects inflation to remain between 1 1/2-1 3/4 percent for the next two years.
  • The step towards inflation targeting is a development that will be closely monitored by the markets, suggesting greater transparency in monetary policymaking.
  • The possibility of a less discretionary approach is expected to be an important issue for the Fed's successor, Ben Bernanke.
  • The Fed's inflation objective has been discussed at the policymaking Federal Open Market Committee, with several members, including Ben Bernanke, favouring a more formal definition.
  • The new, longer-term inflation projection appears to be the result of these deliberations, providing a more stable foundation for monetary policy.
  • The Fed's economic projections now include rates for two years, rather than one, as a further step to enhance monetary policy communications.
  • Mr. Greenspan stressed an upbeat growth outlook, saying that while inflation remained well contained, the Fed would continue raising rates to maintain price stability.
  • The Fed expects growth of 3 1/2-4 percent this year and 3 1/2 percent in 2006, according to the central tendency of the committee's forecasts.
  • The core personal consumption expenditures (PCE) index excluding food and energy is expected to be 1 1/2-1 3/4 percent over the next two years, slightly below the Fed's July forecast range.
  • The step towards inflation targeting is unlikely to be adopted during Mr. Greenspan's tenure as chairman, which ends next year.

Statistics:

  • Inflation is expected to remain between 1 1/2-1 3/4 percent for the next two years.
  • The Federal Reserve expects growth of 3 1/2-4 percent this year and 3 1/2 percent in 2006.
  • The core personal consumption expenditures (PCE) index excluding food and energy is expected to be 1 1/2-1 3/4 percent over the next two years.
  • The Fed's preferred measure of inflation, the core PCE index, rose by 1.5 percent in the year to December.

Sources:

  • ANDREW BALLS WASHINGTON -- The Federal Reserve yesterday took a step closer to setting a formal inflation objective, releasing forecasts showing that it expects inflation to remain between 1 1/2-1 3/4 per cent for the next two years. The step suggests greater transparency in monetary policymaking, a development that will be closely monitored by the markets. It also points to possible new thinking inside the Fed as the long chairmanship of Alan Greenspan draws to an end. "They are telling us they have become de facto inflation targeters," said Angel Ubide, a Fed watcher at a Washington-based hedge fund. "They are telling us that 1 1/2-1 3/4 is the target, based on their expected policy path."
  • The New York Times: "Fed Officials Discuss Inflation Targeting"
  • Federal Reserve: "Federal Open Market Committee"

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