Fed revives discussion of explicit inflation target

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: Federal Reserve officials revived the prospect of setting an explicit target for inflation to counter the risk that the worst economic slump in the postwar era will trigger a broad decline in prices. The Federal Open Market Committee, at its December 15-16 meeting, discussed ways to avert deflation while approving a reduction in the benchmark interest rate to as low as zero, according to minutes of the gathering released on Tuesday. The FOMC also considered increasing emergency loans that have doubled the Fed's balance sheet to $2.3 trillion in the past year. Policy makers "face considerable uncertainty about how inflation expectations could evolve," said Brian Sack, deputy director at Macroeconomic Advisers LLC in Washington and a former Fed economist. "That enhances the argument for taking the further step and adopting an explicit inflation objective."

By setting a goal for price increases, the central bank would adopt a measure that the UK, Sweden and other countries have used to anchor policy and build credibility with the public. Chairman Ben S Bernanke made a target one of his priorities when he took the helm three years ago, though a 2007 review of Fed communications stopped short of that objective. Now, with inflation retreating and the economy contracting, a target could be used to justify a more expansive policy. One measure of inflation, the personal consumption expenditures price index, minus food and energy, could rise at less than 1% this year, and only 0.5% in 2010, according to forecasts by Sack's firm.

Central bank officials discussed providing "a more explicit indication of their views on what longer-run rate of inflation would best promote their goals of maximum employment and price stability," the minutes said. Such a target may "help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low."