Fed's Williams Says Price-Level Targeting May Be Good Regime for Fed

Federal Reserve Bank of San Francisco President John Williams says fundamental uncertainties about the economy mean officials may need to weigh a seismic shift in how they conduct monetary policy.

Mr. Williams spoke with reporters Friday in conjunction with the release of a research note of his flagging the uncertainty entailed in measuring the economy's potential output level. Understanding how much the economy can produce is a key factor in determining whether growth is sustainable.

That inability to know how fast the economy can grow without creating inflation, or how low the unemployment rate can go before it sparks inflation driving wage gains, makes it all the more challenging for central bankers as they decide what level of interest rates is correct to keep the economy moving forward without overheating.

Mr. Williams says the issue gains urgency because changes in the economy mean the Fed is unlikely to raise rates as high as it did in the past. If its short-term rate target is lower than historical experience, it will have less space to lower it to provide stimulus in the event of new economic trouble. Stimulus then must come from other unorthodox strategies, which are often controversial.

Mr. Williams said it is time for the Fed to start thinking about how it could provide better stimulus in such an environment. He believes a regime called price-level targeting may be the way forward.

Under such a system, the Fed targets a given path of inflation increases, and then does what it takes to achieve that level. It would be a change from the current system, in which the Fed seeks to achieve maximum sustainable job growth coupled with a 2% inflation rise. Right now, the Fed is seeing levels of unemployment it believes should be creating higher inflation, yet it has fallen short of achieving its price rise goal, first adopted in 2012, for years.

Mr. Williams explained how price-level targeting would work.

"If your price level is below target like it is obviously today, because we've had years of running the inflation rate below our target and the price level is now well below what the target would have been if we had a price level target in 2012, it would say just keep stimulating the economy without really focusing on is this the right employment or output level," Mr. Williams said.

"It would just say keep stimulating the economy until you get that price level back up," he said.

Mr. Williams says such a system would also work better when the risks of short-term rates falling back to near-zero levels remains omnipresent, as is the case now.

Price-level targeting helps drive home the point that even if short-term rates hit near-zero levels, rates will stay ultra low until price pressures start to rise again, he said. Without such a system officials would need to explicitly signal that, and the uncertainty of that process may blunt some of its impact.

Price-level targeting is "a powerful way to cope with the zero lower bound, but it has advantages even away from that, given the uncertainties of things like the natural rate of interest, the natural rate of unemployment, and what potential output is," Mr. Williams said.

In his call with reporters, Mr. Williams said his views on price level targeting don't apply to any of the Fed's current decisions on rate rises. Instead, it is a debate the Fed needs to start having soon to get ready for challenges that may come down the road.

"I think we need to think seriously about how we would do one or a combination of these to prepare ourselves better for that next storm," Mr. Williams said.

Write to Michael S. Derby at michael.derby@wsj.com

(END) Dow Jones Newswires

November 06, 2017 13:14 ET (18:14 GMT)