FED FOCUS-Fed's focus on jobs lays path for inflation target

Feb 6 (Reuters) - When Federal Reserve officials gathered in late 2006 to talk about setting an inflation target, most favored the idea but worried Democrats in Congress would cry foul.

However, when the U.S. central bank finally laid out a target last month, there was nary a peep from Democrats, who in years past had argued an explicit numerical inflation goal would lessen the Fed's focus on employment growth.

Indeed, when Fed Chairman Ben Bernanke testified before Congress last week, the biggest critic was Paul Ryan, a Republican congressman who suggested a long-term target would tempt the Fed to go soft on prices in the near term.

The lack of political fireworks may have been due to some deft lobbying by Bernanke, as well as a feeling the target would not bring a sea change in how the Fed operates - a view widespread in financial markets.

"The chairman consulted personally and very broadly with key members of Congress on both sides of the aisle," Dallas Federal Reserve Bank President Richard Fisher told reporters on Thursday. "I'm not at liberty to tell you what each one said. But he did this himself, a very broad range on consultations."

A Fed spokeswoman declined to provide details.

Whatever the reason, the quiet was notable, given the hand wringing within the Fed just a few years ago about the potential for political blowback. The Fed is charged by Congress to pursue both price stability and full employment.

"It's extremely important that we not be considered what (Bank of England Governor) Mervyn King has artfully called 'inflation nutters'," then Fed Governor Frederic Mishkin warned at a policy gathering in October 2006. "We do need to consider the likely interaction with the Congress as we set a target for one of our goals but not another."

Fisher at the time was blunter: "We have to be careful of the risk that either you then have them say, 'That's fine, but tell me what your employment target is because you have a dual mandate,' or you end up negotiating an inflation target higher than you want it to be."

To the No. 2 official at the Atlanta Fed, Patrick Barron, the political risks were enough to put him off the idea altogether. "I think to do so would simply lure them into a fight that I wouldn't want to take on at this time," he said, according to the meeting transcript released last month.

Lobbying aside, the path to adopting an inflation target of 2 percent was smoothed by the Fed's clear efforts to keep an aggressively stimulative monetary policy in place.

Even as it announced its new inflation goal, the central bank vowed to keep interest rates exceptionally low for nearly three more years, and said that its new, stronger anchor for inflation expectations could give it more leeway to take measures to boost jobs.

"The action was taken in the context of extending the potential period for near-zero interest rates, an easing action, so it wasn't associated with a new emphasis on containing inflation at the expense of unemployment," former Fed Vice Chairman Donald Kohn said.

'TERRIBLE MISTAKE'

In academia, Bernanke had been in the vanguard of inflation targeting proponents, and during his first nomination hearing for the Fed chairmanship, he laid the case at Congress' feet.

A target "could have several advantages, including further reducing public uncertainty about monetary policy and anchoring long-term inflation expectations even more effectively," he said.

Some Democrats were openly hostile to the idea. In 2007, Barney Frank, the powerful chairman of the House Financial Services Committee, said it would be a "terrible mistake" that could take the Fed's eye off its full employment goal. Frank did not reply to a request for comment for this article.

But in adopting a target, the Fed went to pains to explain it was equally concerned with jobs. And with inflation slowing and the Fed keeping its foot on the monetary accelerator, Democrats may have few bones to pick.

"There is no point in starting a fight with the Fed when you agree with them on the appropriate course of policy," said JPMorgan chief economist Michael Feroli.

Back in October 2006, that was not the case. The Fed was worried about rising inflation and, while it held policy steady, Bernanke urged officials to continue with "verbal tightening."

As he wrapped up the discussion of inflation targeting, Bernanke made clear his concerns over how an explicit price stability goal might be greeted politically.

"Whatever we say here, we have to persuade the Congress and the public that we will look at both parts of the mandate and that we will not reduce out interest in employment and output," he said.