UPDATE: Fed’s Bullard: Inflation Too Low; May Need Response

The Wall Street Journal, April 17, 2013. All Rights Reserved.

NEW YORK–Federal Reserve Bank of St. Louis President James Bullard on Wednesday said he is concerned inflationary pressures may be growing too weakly and the central bank may have to do something about it.

"Inflation is running very low" as measured by the personal consumption expenditures price index, the Fed’s favored inflation gauge, the policymaker said. "I’m getting concerned about that," he said, adding that the low rate of price pressure "gives the [Federal Open Market Committee] some room to maneuver" on the monetary-policy front.

The central banker didn’t suggest that any move toward a more-stimulative monetary policy was imminent. The Fed is currently pursuing a policy of buying bonds to drive up growth and lower the unemployment rate. While most expect the bond-buying program to continue for some months to come, improving economic conditions have driven some central bankers to say the pace of buying could be reduced at some point.

The Fed wants inflation at 2% and it considers under-target inflation to be undesirable. Central bankers consider a deflationary environment as damaging to the economy.

In his speech, Mr. Bullard also appeared to take issue with the central bank’s latest move to provide increased monetary-policy guidance, saying the Fed is limited in what it can do to affect labor-market conditions.

The best and most-effective action the Fed can take is to focus on its traditional mandate of inflation control, the official said. "Frontline research suggests that price stability remains the policy advice even in the face of serious labor-market inefficiencies," Mr. Bullard said. "This research should provide the benchmark for contemporary monetary policy," he explained.

At the same time, "the current high level of unemployment is causing some to suggest that the [FOMC] should put more weight on unemployment in its decision-making process," he said. That would be a mistake, he said, as research shows "monetary policy alone cannot effectively address multiple labor-market inefficiencies…One must turn to more-direct labor-market policies to address those problems."

Monetary policy by itself is "too blunt" to help lower high unemployment levels, the policymaker said. When it comes to aiding the labor market, "it’s not that you can’t do something about it, it’s just that maybe you shouldn’t lean on the monetary-policy maker" to do it.

Mr. Bullard is a voting member of the monetary-policy-setting FOMC. His comments came from a speech given before a conference held by the Levy Economics Institute of Bard College, in New York. Much of his talk referenced work by economists Federico Ravenna and Carl Walsh.

Mr. Bullard has long argued that monetary policy faces limits in what it can do to aid the labor market, and he has said that, if the Fed were to target achieving a given unemployment rate, it could lead policy to go seriously wrong. But he also gave his qualified support to the Fed’s decision last December to job and inflation thresholds.

At that time, the Fed said it would keep short-term interest rates near 0% so long as the unemployment rate is above 6.5% and expected inflation is below 2.5%. Officials have been careful to note that these levels aren’t targets and that they don’t promise immediate action if breached. Some have said the Fed could easily keep rates unchanged with a sub-6/5% unemployment rate if inflation remained under the threshold.

The Fed’s new policy guidance reflects in large part its congressionally given mandate to keep prices stable and to promote maximum sustainable job growth. The Fed is unique among major central banks in having this goal, with other major central banks charged with pursuing stable inflation alone.

Mr. Bullard’s comments Wednesday appeared to reflect an ongoing discomfort with this new policy regime, one that is unlikely to bring a rate increase for several more years if the Fed is right about how the labor market will perform.

In his prepared remarks, Mr. Bullard said the Fed over recent years has done a good job of keeping inflation near the central bank’s official target of 2%. He said the unemployment rate "remains high" and, compared to its current 7.6% level, it will likely be in the "low-7% range" by year’s end.