Thank you, Mr. Chairman. Relative to previous meetings, there has been considerably more discussion of inflation and disinflation at this meeting. I’m gratified about that because I think these considerations should be central to our policy analysis at this point. Let me just add a few points to the discussion.
Disentangling persistent from temporary changes in the rate of inflation is difficult, and measurement issues cloud the picture further. Nevertheless, the best guess is that underlying inflation has been declining recently. Comparing the year ending in March 2003 with the year ending in March 2002, the Greenbook notes that inflation as measured by the core CPI has fallen from 2.4 to 1.7 percent. In the past six months this measure has been barely above 1.0 percent at an annual rate. Inflation as measured by the chain version of core CPI has fallen from 1.8 percent last year to 1.2 percent this year. Data for the past six months are not available. Inflation as measured by the core PCE deflator has been stable at 1.5 percent for the past two years, but the Greenbook notes that this stability is largely a result of increases in nonmarket imputed prices. Excluding nonmarket prices, core PCE inflation fell from 1.3 percent in the year ending March 2002 to 0.9 percent in the year ending March 2003, and it has averaged 0.2 percent over the past six months. Of course, for a given nominal funds rate, disinflation amounts to a de facto tightening of monetary policy.
Because monetary policy works with a lag, in principle we should be most concerned about the forecast of future inflation rather than past inflation. Forecasting inflation is tricky, though it is worth pointing out that several well-known academic studies have found that the Greenbook’s forecasts of inflation are better than any made in the private sector. The staff estimates that core PCE inflation will be about 1.0 percent in 2004, owing largely to the fact that even with growth of nearly 4 percent in the second half of this year and in all of 2004, the economy would still have considerable slack well into next year.
Of course, as always there are both upside and downside risks to the staff forecast. However, our loss function with respect to the inflation forecast error should be asymmetric. A 1 percentage point undershoot of inflation from the forecast, which would bring us to the brink of outright deflation, would be much more costly than a 1 percentage point overshoot, undesirable as the latter might be. In short, for the first time in many decades the risks to our inflation objective are decidedly downward. Given that the risks to employment also seem to be downward, there appears to be a prima facie case for easing policy. I tend to agree with that conclusion, and barring an exceptionally strong near-term turnaround in the economy, I hope that the Committee will adopt a posture of leaning toward ease.
I would like to add an important caveat, however. The chance that we will hit the zero bound constraint at some point, though not large, is certainly not negligible. In response to President Guynn’s earlier remarks, by the way, I believe a zero bound constraint on policy is the major risk of a deflationary environment—one that could have real costs because it would inhibit our ability to stabilize the economy. More generally, as noted by Governors Kohn and Ferguson, deflation puts a floor on the real interest rate and can therefore destabilize and distort capital markets. Theoretically the risk of the zero bound only increases the urgency of a preemptive easing. However, it also seems important that we have a plan for how we might proceed seamlessly from standard rate-cutting to more nonstandard operations should such operations become necessary. For me, along the lines suggested by President Hoenig, if there is an argument for delaying further easing at this point, that is it. A delay would give the Committee a chance to think about how an easing action fits into a broader strategy that may involve—though we hope it will not—nonstandard policy operations. Thank you.