New Risk For Investors: Fed Considers Jacking Up Inflation Target
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Investors are underestimating inflation risk. As a consequence, they are under-pricing inflation protecting assets including precious metals.
The Federal Reserve has given itself the objective of engineering an inflation rate of around 2%. However, there are many ways in which real-world inflation can potentially outpace the Fed’s 2% target.
Firstly, the Fed’s preferred inflation gauges are flawed. The so-called “core” rate of consumer price inflation strips out food and energy costs. The core Personal Consumption Expenditures (PCE) index has also been criticized for underweighting housing and medical costs.
The PCE number for March, which came out on May 1st, shows the Fed’s favored inflation gauge running at 1.6% year over year. That’s down slightly from the previous month’s reading of 1.8% (2.1% for the headline unadjusted PCE).
Since 2012, the core inflation rate has been running below the Fed’s 2% target. That has caused investors to grow complacent toward inflation risk. They seem to be operating under the assumption that 2% is a ceiling.
That is a dangerous assumption – not only because of food and energy inflation not being properly accounted for, but also because even the official “core” number could rise well above target for extended periods.
Fed Insiders Call for 4% Inflation Target
The 2% target itself isn’t set in stone. In fact, some current and former Fed governors would like to see the central bank pursue a more flexible inflation objective. Peterson Institute economist Olivier Blanchard argues the Fed ought to raise its target to 4% in order to make up for several years of below-2% inflation.
Former Federal Reserve chairman Ben Bernanke recently wrote a piece for The Brookings Institution in which he proposed ways to re-jigger the Fed’s inflation target. According to Bernanke, “in a changing world of imperfect credibility and incomplete information, private-sector inflation expectations are not so easy to manage.”
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