The Fed Versus Price Stability

SAN FRANCISCO – There is a big difference between the Federal Reserve’s mandate to maintain “stable prices” – as enunciated in the Federal Reserve Act – and the Fed’s self-selected target of 2% annual inflation. So how is it that policymakers have managed to substitute the latter for the former?

The term “stable prices” is self-explanatory: a bundle of goods will cost the same ten, 50, or even 100 years from now. By contrast, if a country experiences 2% inflation over a ten-year period, the same items that $100 can buy today will cost $122 at the end of the decade. After 100 years, the price tag will be a whopping $724.

In her recent Congressional testimony, Fed Chair Janet Yellen referred several times to the mandate of maintaining “stable prices”; but she mentioned the Fed’s 2% inflation objective twice as often. “US inflation continues to run below the Committee’s 2% objective,” she said, and the current “high degree of policy accommodation remains appropriate to foster further improvement in labor market conditions and to promote a return of inflation toward 2% over the medium term.”

Does the Fed really want to increase annual inflation to 2%, such that the price level of the country will increase by more than 700% over the next century? Is that what Congress had in mind when it tasked the Fed with achieving “stable prices”?