“I don’t get it,” Volcker said, leading to a lively back and forth between the two central-bank heavyweights.
By setting 2% as an inflation objective, the Fed is “telling people in a generation they’re going to be losing half their purchasing power,” Volcker said. And if 2% is the best inflation rate, and the economic recovery lags, does that mean that 3% becomes the ideal rate, he asked.
Kohn responded that by aiming at 2%, “you have a little more room in nominal interest rates … to react to an adverse shock to the economy.”
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“Your problem is two [percent] becomes three becomes four,” Kohn told Volcker. But other central banks with a roughly 2% target haven’t had that problem, Kohn said.
Fed officials, Kohn added, “need to be clear about why we’re choosing the number we’re choosing.” He also said that while he doesn’t think deflation is much of a risk, “I can’t say the risk is zero” and the Fed must be mindful of the possibility that inflation expectations fall to the point that real interest rates rise.
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Kohn and Volcker fought to a rhetorical draw, with each conceding that he wasn’t going to persuade the other.
As reported by Wall Street Journal's Real Time Economics Blog.