UPDATE 1-Fed's Kocherlakota floats overshooting US inflation in future

Wed May 21, 2014 1:38pm EDT

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(Adds background on inflation targeting debate)

By Jonathan Spicer

MINNEAPOLIS May 21 (Reuters) - U.S. inflation may not climb back to 2 percent until 2018, so the Federal Reserve should consider overshooting that target for a few years afterward to make up for the current period of low prices, a top Fed policymaker said on Wednesday.

Narayana Kocherlakota, president of the Minneapolis Fed, floated the idea of "price level targeting" but did not explicitly endorse it, saying in a speech the idea deserves "serious discussion" at the U.S. central bank.

Under price level targeting, the Fed would let inflation run above its 2-percent goal in the years ahead to make up for the currently low prices for goods in the economy. As it stands, the Fed practices "inflation targeting" in which it aims for the goal at all times irrespective of past trends.

The Fed's preferred gauge of inflation, the personal consumption expenditure or PCE, has averaged 1.5 percent since the start of the recession in 2007. It is now just above 1 percent, which Kocherlakota said signals "wasted resources" in the U.S. economy, especially among workers.

If the central bank were to move to target prices, businesses would be more prone to hire and invest because they would predict more stimulative future monetary policy and higher demand. Such a decision "has the potential to affect the near-term speed of the economy's recovery," Kocherlakota told the Economic Club of Minnesota.

A voter on Fed policy this year, Kocherlakota added he expects PCE inflation to run below 2 percent "for several years, possibly until 2018."

The Fed has kept interest rates near zero since late 2008 to promote growth and hiring. In part due to the last couple of years of low inflation, it has also promised to keep rates low for a while to come.

Kocherlakota recently backed off his most recent attempt to boost accommodation: convincing the Fed's other 15 policymakers to lower a stated unemployment threshold that would signal they would considering raising rates. Instead the Fed has simply said it would keep rates low for a "considerable" time after it stops buying bonds.

Kocherlakota said price targeting would make long-term contracts safer for both borrowers and lenders, since inflation would average closer to 2 percent over years. And, he said, it would serve as an automatic stabilizer for the economy.

Chicago Fed President Charles Evans, who like Kocherlakota is a dovish policymaker at the central bank, also floated price level targeting a few years ago as a way to ramp up monetary stimulus.

Most of the world's central banks target inflation and not prices, for fear of letting inflation get too hot. (Reporting by Jonathan Spicer; Editing by Chizu Nomiyama)

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