By Howard Schneider
WASHINGTON (Reuters) -A group of former top world central bankers says the Federal Reserve should scrap its nearly five-year-old bias towards jobs and keep a stricter focus on inflation, a recommendation offered as the U.S. central bank conducts its own strategy review.
The Fed should “always seek to bring inflation back to its 2% inflation target” and drop the current pledge to use periods of high inflation to offset periods when prices rise too slowly, said the panel, chaired by former New York Fed President William Dudley and including former central bank officials from China, Mexico, Japan, England, and Israel.
The current approach of ignoring low unemployment as an inflation risk and viewing maximum employment as a “broad-based and inclusive goal” should also be dropped, the group said.
“The Federal Reserve’s monetary policy tools are ill-suited to ensuring that employment will necessarily be broad-based and inclusive when the economy is at full employment,” the group said in a report issued by the G30, a private organization of former top central bank and finance officials. “Including this language in the Federal Reserve’s monetary policy framework commits the Federal Reserve to an objective that the Federal Reserve cannot achieve in practice if it also wants to hit its 2% inflation target.”
The language on jobs was developed in the context of heightened concerns about economic inequality in the U.S. and tensions over police violence in U.S. cities.
The Fed is in the middle of its own review of that operating strategy, which was put in place in August 2020, when the economy was still struggling through the COVID-19 pandemic and the aftermath of an unprecedented economic shutdown.
Fed officials already seem inclined to revise their approach given the inflation struggles that emerged, though debate remains on key issues like how to manage potential tradeoffs between inflation and unemployment, and how to better describe the central bank’s use of bond purchases as a monetary policy tool.
‘LAST WAR’
The G30 report, released on Wednesday, said the Fed’s current framework made sense emerging from the 2010-2020 era of weak inflation and low interest rates, but slowed the Fed’s response as inflation pressures began building in the wake of the pandemic and made the whole episode riskier than it needed to be.
The framework, which led the Fed to promise it would keep interest rates low and continue buying government securities until the job market was healed from the pandemic shutdown, “weakened the inclination for the Fed to be preemptive as the risks to the outlook changed” and inflation began rising, the G30 report concluded.
“In essence, the Fed ended up fighting the last war” from an era when inflation seemed lodged below the central bank’s 2% target, and low rates of unemployment did not seem to have the same impact on rising prices, as had been the case in previous business cycles.
The response, a combination of allowing higher inflation as a “make-up” strategy and pledging not to view low unemployment in itself as an inflation risk, made the Fed “slow to respond to evidence of strong growth, an extraordinarily tight labor market, and rising inflation in 2021.”
While subsequent rate hikes cooled inflation, the episode raised the risk the Fed would lose control of public expectations and have an even worse problem to fix. The rapid pace of rate hikes that was eventually used to attack inflation, meanwhile, contributed to stress in the financial sector.
The group also recommended that the Fed change how it manages interest rates, issue more robust forecasts, and offer more explicit guidance on its use of bond purchases.
(Reporting by Howard Schneider; Editing by Paul Simao)
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