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The Fed’s outlook and views on inflation
While it isn’t discussed that much, the Fed does have a dual mandate to contain inflation as well as support employment growth. Historically, this has meant that the Fed must maintain interest rates such that it controls inflation. However, the Fed has set an inflation target of 2%, and lately, inflation has come in below that number. It’s important to remember that while the Fed fears inflation, it fears deflation more. This is because when interest rates are at the zero bound, deflation raises real interest rates. So the Fed will pull out all the stops trying to prevent that.
Bernanke noted that consumer price inflation has been running below the FOMC (Federal Open Market Committee)’s long-run target rate of 2%. He does consider some of this to be due to transitory effects (read, the dollar and commodity prices) and he hopes that inflation will revert back to the mean of about 2%. He addressed low inflation directly: “The Committee is certainly aware that very low inflation poses risks to economic performance—for example, by raising the real cost of capital investment—and increases the risk of outright deflation. Consequently we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2 percent objective over time.”
The prepared comments cautioned that the present path of beginning to taper quantitative easing wasn’t a preset path and that if inflation remained below the target rate, the committee would reconsider tapering quantitative easing. In the question-and-answer session, Bernanke said that he would not increase the Fed Funds rate as long as inflation remained below its target rate. Bernanke was asked a couple of times about the risk of hyperinflation, and he more or less dismissed it out of hand by saying that people have been warning of runaway inflation for years and we’re still seeing 1% inflation. He also didn’t see any bubbles forming.
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