In 2012, following their January 25 meeting, the Federal Reserve issued a press release that included their first stated commitment to an inflation target. “The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures (PCE), is most consistent over the longer run with the Federal Reserve’s statutory mandate”. Pioneered in New Zealand in 1990, the Federal Reserve became the 24th central bank to adopt an inflation target, following in the footsteps of such monetary policy luminaries as Brazil, Armenia and Guatemala.

Prior to this adoption, the Federal Open Market Committee (FOMC) regularly announced a desired target range for inflation, usually between 1.0% and 2.0%. Moving from a range to a specific target went hand in hand with the broader push for increased transparency on the part of the FOMC. The belief was that increased transparency would enhance the effectiveness of monetary policy and ease the way for its acceptance and implementation and eventual success. We have always found it curious that investors and consumers need to be told what level of inflation is good or bad in the first place. Nevertheless, in the five years that have passed since adopting an inflation target in the United States, we have yet to reach that bogey.

In a speech at an economic conference on October 14, 2016, FOMC Chair Janet Yellen asked a series of questions regarding research around the 2008 crisis and its aftermath. In one instance she invoked the term ‘hysteresis’, an idea that declining demand could have an impact on the supply capabilities of an economy. The theory has been raised in other instances, but has been typically dismissed as inconclusive. However, several studies across many developed countries have shown a slowdown in supply correlating with a slowdown in demand. Thus more researchers are giving the concept more attention. Chair Yellen then asked, “if we assume that hysteresis is in fact present to some degree after deep recessions, the natural next question is to ask whether it might be possible to reverse these adverse supply-side effects by temporarily running a “high-pressure economy,” with robust aggregate demand and a tight labor market”. Most observers took that as an expression of willingness for the economy to run ‘hot’ for a while to counteract some of the worst effects of the slow growth environment.

The Federal Reserve has two mandates; full employment and price stability. The U.S. economy spent 2016 with unemployment ranging from 5.0% down to 4.7% in December. This level is widely considered to represent full employment, leaving only weak inflation as the excuse upon which to rest any argument for continued monetary easing. With inflation steadily marching upward, we expect to see PCE broach the 2% threshold by February (released in late March), an ‘achievement’ that will remove any remaining resistance to raising rates further.

Except for Chair Yellen’s comments from October. We don’t know any more about hysteresis, but she has dealt with the repeating questioning from her suggestion ever since. The FOMC and other central banks, fairly or no, earned a reputation for their willingness to try wildly new policy approaches in their search for sustainable growth. One cannot entirely dismiss the thought that ‘running hot’ is exactly what they would like to do to provide more opportunities for the jobless and push up on wages, whose growth has been weak. Nevertheless, in her latest refutation earlier this week in another speech, Chair Yellon said that “I think that allowing the economy to run markedly and persistently “hot” would be risky and unwise.” Such a statement seems clear on the surface, but there are degrees of difference behind her chosen adjectives that can be very influential. What we are left to consider is this; which outlook will show up when inflation breaks 2% and the votes are called?