(Bloomberg) — WIN: “Want Inflation Now”.
During her almost two years as head of the world’s most influential central bank, Janet Yellen has had a difficult time driving up one thing she directly controls: inflation.
Today’s lack of pricing power stands in stark contrast to the 1970s, when a soaring consumer prices prompted the Ford administration to launch a program known as WIN — “Whip Inflation Now”.
During Yellen’s tenure, the annual rate of change on prices has averaged 0.8 percent — far short of the Federal Reserve’s 2 percent target. Oil has fallen 69 percent since the end of January 2014, wages have been slow to accelerate and the dollar’s 22 percent rise has made imports cheaper.
Additionally, a host of technological disruptions — from Amazon to Uber — have helped curb pricing power. By giving consumers information on what they’ll have to pay for goods and services, these innovations are spurring competition to keep costs low.
While these forces are beyond the Fed’s control, the risk of inflation taking too long to return to target is starting to worry central bankers. Some officials called the decision to raise rates last month “a close call,” particularly given the uncertainty about inflation dynamics, according to minutes released Jan. 6.
Right now, the Fed’s strategy is to wait and hope the effects of cheap oil and import prices wash out. By the end of 2018, inflation will be back on target, their forecasts say.
But the waiting game has risks. A new, lower level of inflation expectations could become entrenched in the economy. What’s a central banker to do?
Fed officials could forgo another rate increase in March, a possibility reflected in futures markets where the probability of no change at that time is around 58 percent.
A pause would fuel expectations of a much slower series of rate hikes than the four that policy makers projected for 2016. Short- and long-term interest rates would drop, resulting in cheaper financing costs that could further stimulate demand in an economy where the jobless rate is already at a seven-year low of 5 percent.
Still, the strategy is riskier than it sounds. The Fed estimates the jobless rate that is consistent with steady price pressures is around 4.9 percent. Foot-dragging on interest rates while labor-market slack continues to diminish could mean Fed officials fall too far behind on their policy setting.
If inflation climbs faster than expected due to the pickup in demand, central bankers will have to raise rates at a quicker pace, “and that increases the risk of a recession,” said Laurence Meyer, a former Fed governor and president of LH Meyer Inc. in Washington.
Fed chairs typically steer clear of advising the legislative branch on spending. Yet if the monetary policy lever is less effective, fiscal expansion is an obvious choice, said Laurence Ball, an economics professor at Johns Hopkins University in Baltimore.
“In the short run, to boost output, we need more demand, which means we need somebody to be spending more money,” Ball said. “The surefire way to have somebody spend money is to have the government spend it.”
For example, increased outlays on infrastructure projects could help put more Americans to work, giving them income to spend and boosting demand. Similarly, if legislators agreed to abolish the payroll tax for a year, “that would be a big tax cut for everybody that would expand the economy a lot,” Ball said. He added that in the current election-year gridlock, such a policy is “politically unrealistic.”