COLUMN-Fed could abandon 'illusion of precision' with inflation range: McGeever

By Jamie McGeever

ORLANDO, Florida, Sept 25 (Reuters) - There's little prospect of the Federal Reserve changing its 2% inflation target right now. But the composition of the Fed's board is changing and Jerome Powell's term as Fed Chair expires in May, so could discussions about an alternative to the fixed 2% target soon begin to percolate?

Figures on Friday are expected to show that U.S. inflation in August exceeded the Fed's 2% goal for the 54th month in a row. Even accounting for all the shocks of recent years and inbuilt flexibility in the Fed's post-COVID inflation framework, that's a long time for a central bank to miss its target.

And there's every likelihood that inflation won't get back to 2% for several more months, probably years. Fed officials' median projections don't expect headline or core PCE inflation to get back to 2% until 2028.

Even that timeline could prove to be tough. The Fed has a dual mandate, and rising risks to the employment side of it have prompted the central bank to resume its interest rate-cutting cycle. But financial conditions are the loosest in years and growth is still humming along at a decent clip, so rate cuts now could stoke price pressures further.

The Fed failing to meet its inflation target is hardly new. But the longer inflation stays above target, the more likely it is that credibility in the target and the Fed's policymaking more broadly could erode.

That may encourage the Fed to rethink the target altogether.

'ILLUSION OF PRECISION'

Changing a target that's been missed every month for over four years - essentially moving the goal posts - is certainly not a good look.

That said, trial balloons are best floated early, and one potential alternative to the current target is an inflation range, which some Fed officials have nodded to recently, most notably Atlanta Fed President Raphael Bostic.

In an interview with George Mason University senior research fellow David Beckworth on the Macro Musings podcast this week, Bostic said he would be open to a range in the future.

"Sometimes there's this illusion of precision, that we can move inflation to the third decimal place. I don't really think that's real," Bostic said.

"In today's environment, we're at 2.4 (percent), 2.6, 2.8, somewhere in that range, and people are asking, is that 2 (percent)? For me? No, my range would be narrower, but it's a good conversation to have," he said, adding that 1.75% to 2.25% would be a good start.

An inflation range carries the obvious advantage of providing policymakers with more flexibility than a specific point. It would give the Fed more license to have inflation above 2% while technically being in breach of its stated goal.

The wider the range, the greater the leeway, although on the flip side, inflation momentum could build up rapidly if left unchecked, forcing uncomfortably aggressive policy responses.

'VAGUER AND LONGER'

While ranges are most prevalent in emerging markets where economic volatility is usually high, they are also used by monetary authorities in advanced economies like Canada, Australia and New Zealand.

Central banks still appear to prefer more precise inflation targets rather than ranges. At least that was the conclusion the Bank for International Settlements came to in a recent study of 26 central banks that had implemented some form of inflation targeting since 1990. However, the BIS also found that the time horizon allowed to meet these more rigid targets has gotten "vaguer and longer" over time.

The latter part of that would certainly apply to the Fed - four and a half years and counting. And if Fed officials think it might take another three years to right the ship, consumers are even more pessimistic.

The latest University of Michigan survey of consumers shows one-year inflation expectations at 4.8% and five-year expectations at 3.9%. These may be on the high side given the apparent fragility of the labor market, but the Fed still won't be happy to see figures this elevated, as unanchored inflation expectations can lead to a wage-price spiral.

In economics, gradual change is usually preferred, at least by markets. So rather than making an abrupt move to a higher inflation target down the line, adopting an inflation range – which the Fed essentially already has – may be something more officials will join Atlanta Fed President Bostic in considering.

(The opinions expressed here are those of the author, a columnist for Reuters)