The Federal Reserve Cautions About "Deflationary Bias"

The U.S. central bank has an inflation-rate target of 2%, but these days, that might be more wishful thinking than a realistic goal.

Inflation has been below the Fed's target for 3½ years, according to the personal consumption expenditures price index, and a new paper suggests that the U.S. economy is now in the grips of a "deflationary bias."

In other words, meaningful economic growth appears elusive.

Researchers say that even negative interest rates (below zero) would fail to lift the inflation rate to the Fed's target.

Read this Feb. 19 Bloomberg article excerpt:

The U.S. economy may be saddled with a "deflationary bias" after the last recession that makes it harder for the Federal Reserve to achieve its 2 percent inflation goal, according to research published this month by the central bank.

Economists Timothy Hills, Taisuke Nakata and Sebastian Schmidt argue that the bias stems from a recognition by companies that the Fed has limited ability to spur the economy when interest rates are low.

That in turn prompts firms to reduce expectations of future costs, affecting what they decide to charge for their products and services.

"Our result provides a cautionary tale for policy makers aiming to raise inflation from currently low levels," the economists wrote in a paper and an accompanying note. "Achieving the inflation target may be more difficult now than before the Great Recession." ...

At the core of the paper is an assumption that the zero lower bound on interest rates constrains the Fed’s ability to promote faster economic growth and higher inflation. It is that constraint -- and the likelihood that the central bank will encounter it more frequently in the future -- that prompts companies to lower their inflation expectations.

However, even if the Fed pushed rates below zero to a negative half percentage point, the model finds that inflation would still fall short of the central bank's goal, albeit not by as much as otherwise.

You can read the entire article by following the link below: