Policy makers at the Federal Reserve are playing with American’s expectations: they want people to think that inflation will accelerate in the near future, to encourage spending now.
The central bank is seeking ways to boost the slow economy, after interest rates were lowered to almost zero as well as a $1.7 trillion spend on securities failed to adequately jump-start the US economic situation. The options on the cards at present are raising the expectation of inflation, and expanding the balance sheet with a Treasuries purchase.
Minutes to the Fed’s September 21 meeting were released giving the details of the central bank’s concerns and policy ponderings. According to the minutes, some Fed policy officials were concerned that the expectations of lowered inflation will turn into a self-fulfilling prophecy, which would dampen demand and increase the cost of borrowing. The Fed is therefore speculating on whether increasing the expectation of inflation might encourage Americans to expect prices to rise, which would enable the Fed to reduce interest rates and hopefully stimulate the US economy.
Dean Maki, chief economist at Barclays Capital’s US branch in New York has said of the plan “The theory is elegant, but it’s unclear in practice whether short-term moves in inflation expectations really drive real growth.”
It is a more or less untested theory in the US economy, and while it may work well, it could also backfire and drive inflation higher than the Fed anticipates against the rate they lower interest rates to in real-terms.
