Weak jobs could give Fed inflation target cover

WASHINGTON/CHICAGO (Reuters) - Stubbornly high U.S. unemployment could help the Federal Reserve embrace a new tool for spurring economic growth: telling the world exactly how much inflation it wants.

The Fed may soon inject billions of new dollars into the sputtering economy, but some U.S. central bankers say this so-called “quantitative easing” strategy may do little good.

At the same time, worries persist that prices could eventually enter a downward spiral, compounding economic woes. With the jobless rate at 9.6 percent, wage gains have been sluggish, putting downward pressure on prices.

Policymakers are mulling a campaign to convince the nation it will face higher inflation down the road as a way to combat the risk of a potentially debilitating deflation.

The hope would be such a plan could spur more borrowing now. If businesses viewed the promise of higher inflation as credible, they would be more confident loans taken out today would be easier to repay in the future, when inflation will have pushed their sales revenues higher. The extra borrowing could then boost growth.

Fed officials in September discussed using a more explicit inflation target to accomplish this, according to minutes from the meeting released on Tuesday.

Some U.S. politicians have been hostile in the past to the idea of inflation targeting because such a focus appears to neglect the Fed’s other mandate: keeping the country employed.

Adopting a target when inflation is high would be tough politically because it would imply a need to raise interest rates, bringing pain on companies who might cut jobs. Politicians don’t like that.

But today’s low inflation environment could lower the political hurdles to setting a target, said William Gavin, a vice president at the St. Louis Federal Reserve Bank.

“You wouldn’t have the cost of having to lower the inflation rate to get to the target,” Gavin told Reuters in a telephone interview.

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The Fed already has announced a long-term inflation projection of 1.7 percent to 2.0 percent that acts as an informal target. In the year through August, the core personal consumption expenditures price index -- the Fed’s preferred inflation gauge -- rose 1.4 percent. The core consumer price index was up a more-subdued 0.9 percent.

Setting a formal target would be an effort to underscore the Fed’s commitment to do what it takes to move inflation higher, a commitment the central bank would hope affects the rate of future inflation businesses and consumers expect.

If the Fed fostered higher inflation expectations, it could impact wage and price setting in a way that could become self-fulfilling.

Many central banks around the world, including the European Central Bank, have formal targets. While it is not clear how many Fed officials support joining those ranks, they did discuss their options at their last meeting in late September.

In the past, some officials have argued a target could inhibit the Fed’s flexibility -- but such concerns could fall by the wayside if policymakers feel they need to reach more deeply into their toolkit to battle a potential deflation.

Indeed, officials ran through a number of ways to boost inflation expectations at their meeting, including a potential strategy to shoot for above-target inflation to make up for lost ground when inflation falls short of their objective.

Many academics think this idea -- known as price-level targeting -- is clever but less likely to be adopted because of its complexity.

Fed Chairman Ben Bernanke appeared cool to the idea in August, when he said it could put the central bank’s hard-won low-inflation credibility at risk at a time inflation expectations were well anchored.

He will have a chance to provide an update on the Fed’s latest thinking when he speaks on conducting policy in a low-inflation environment at a conference on Friday.

“A quite likely outcome is that they will just take a small step toward more conventional inflation targeting, which is to say that the target is for between, say, 1-1/2 and 2 percent,” said Jeffrey Frankel, a Harvard economist and an adviser to the New York Fed.

Officials also considered setting targets for nominal growth of the economy.

Even if the Fed didn’t succeed in boosting growth by much with such a policy, a GDP growth target could help keep the public from betting prices will fall, helping to avoid deflation.

“If they succeed in erasing fears of deflation, which is what they are afraid of now, that would be enough of an accomplishment and then they don’t have to do anything fancy,” Frankel said.