Controversial US Inflation Outlook Mars Rate Hike Prospect for Fed

© AP Photo / Andrew HarnikThe Marriner S. Eccles Federal Reserve Board Building
The Marriner S. Eccles Federal Reserve Board Building - Sputnik International
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With US inflation weak, the planned Fed rate hike may harm US growth unless the inflation target is moved upward and the actual hike is postponed until at least December.

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Kristian Rouz — While select officials at the US Federal Reserve see short-to-mid-term acceleration inflation as sufficiently robust to support a cautious and gradual increase in borrowing costs, the overall picture is more complicated.

The long-anticipated hike in US Fed base interest is likely to slow the pace of expansion in the broader economy, and while the robust increase in Q2 GDP of 3.7% allows for such amove, the ongoing appreciation of the greenback, whilst causing additional deflationary pressure, might turn out to be a heavier blow to economic activity.

The most recent inflation figures for July have shown the weakest annualized increase in prices since March 2011, at 1.2%, while monthly price gain has been nearly flat for four consecutive months, at 0.1%.

The Fed outlook is painting a brighter picture, as outlined by Vice Chairman Stanley Fischer on Saturday, with inflation allegedly gaining momentum due to the fading negative impact of the dollar's appreciation, however, that is hardly the case.

International markets are still anticipating a hike in US borrowing costs and investors are buying into the dollar, allowing the US currency to strengthen further and impairing US inflation. Until the Fed makes a move, this pattern is unlikely to change.

However, in order to change that, US monetary authorities could tweak their inflation target, moving it higher, from the current 2% up to 3-4%.

Recently, President of Boston Fed Eric Rosengren, along with his Minneapolis colleague Narayana Kocherlakota put forth the idea of lifting he US Fed inflation target to 4%, a move, they argue, allowing more room for rate cuts in case of future crises.

It is true that implications in US monetary and fiscal policy (with near-zero base interest and a heavy debt burden at 75% GDP) render the nation exposed before a possible global economic turmoil. This is the reason the US Fed is so eager to hike base interest this year.

However, would a higher inflation target help real economic expansion, if combined with several consecutive hikes in borrowing costs? It is hardly so.

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The inflation target is not an actual macroeconomic figure, it is an imaginary projection into the future, affecting the tools of monetary policy like interest rates and current inflation, but having little to none impact on real GDP.

That said, lifting inflation targets could help inflation sometime in the nearest future, but its immediate effect for real economic expansion in case of a simultaneous rate hike would affect no more than 0.1% of GDP dynamics.

Current US inflation is weak, and anything more that a symbolic hike in borrowing costs might cause moderate deflation, effectively eating away at economic growth.

An immediate rise in inflation targetsmight have contributed to the acceleration in real inflation to just above 2% by late 2015, allowing for a harmless December hike. Unless the Fed acts in such a manner, a potential mid-September or October hike will severely maim a Q3 economic expansion.      

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