How Much Is Too Much?

Federal Reserve Chairman Ben S. Bernanke advocates adopting
Federal Reserve Chairman Ben S. Bernanke advocates adopting "inflation targeting," a practice that is used by central banks in 25 countries. (Jim Young -- Reuters)
By Nell Henderson
Washington Post Staff Writer
Wednesday, October 25, 2006

Behind the closed doors of the Federal Reserve's marble temple on Constitution Avenue, a fervent debate is underway this week. The subject might seem, at first glance, to reflect minor differences of opinion.

Should the Fed explicitly tell the public what level of inflation it wants to achieve? And if so, should that goal be in the 1 to 2 percent range, or "comfort zone," expressed by many central bankers in recent years, or should the upper limit be raised to as high as 3 percent?

Close as those numbers may sound, the implications for every American family are substantial. If the Fed enforces a low-inflation goal vs. one that is slightly higher, consider what a pair of pants or a loaf of bread would cost a decade from now, assuming they track the overall inflation rate.

If inflation runs a modest 1.5 percent a year, typical of the level in the late 1990s, a $70 pair of pants would cost $81.24 in 10 years and a $2.79 loaf of bread would cost $3.24. But if inflation, running at more than 2 percent recently, is allowed to creep up to 3 percent a year, those pants would cost $94.07 in a decade, and the bread would cost $3.75.

How much people's paychecks will buy in the future, how far their retirement money will go, how many people might need to be thrown out of work to achieve a stated inflation goal -- all these outcomes could be influenced by a debate among the nation's central bankers at their meetings yesterday and today, to which the public has no access.

Among the main topics to be discussed is how the Fed might communicate more with the public about its private deliberations, economic forecasts, goals and strategies.

One option, long-advocated by Chairman Ben S. Bernanke, is for the Fed to adopt a formal, numerical inflation goal, a practice called inflation targeting and used by central banks in 25 countries. The Bank of England, for example, is one of several central banks that seeks to keep inflation at or near 2 percent.

Alan Greenspan, Bernanke's predecessor who retired in January, opposed inflation targeting, uneasy with rules that might limit his flexibility. He defined the Fed's goal of "price stability" more vaguely -- as inflation so low it does not influence consumers and businesses.

As long as Greenspan was chairman, inflation targeting was moot at the Fed. That changed overnight with President Bush's selection of Bernanke. His arrival has moved the issue to the top of the Fed's agenda.

The policymaking Federal Open Market Committee includes supporters and skeptics, making a quick decision unlikely. If committee members ultimately decide to adopt a target in principle, the next challenge would be setting the number.

Bernanke is among many Fed policymakers who have said in recent years they prefer to keep inflation in a range of 1 to 2 percent, using the central bank's preferred measure, which excludes volatile food and fuel prices. Such pronouncements about "core inflation" have led financial markets to view this range as the Fed's comfort zone, or informal target.

But some Fed committee and staff members believe the range of 1 to 2 percent may be too low. They think a better range might be 1 to 3 percent, or perhaps 1.5 to 2.5 percent.


CONTINUED     1        >

© 2006 The Washington Post Company