WASHINGTON: Battle lines are drawn at the Federal Reserve between those who favour formal inflation goals and those who do not, and the debate is heating up ahead of the coming retirement of Chairman Alan Greenspan.

Vice-Chairman Roger Ferguson and Board Governor Ben Bernanke staked out opposing positions on price targets at a St. Louis Fed bank conference earlier this month.

Bernanke is for targetting and Ferguson - joined by Governor Donald Kohn - is against.

"When central banks are not tightly focused on achieving a specific objective ... policy-makers may be granted a degree of discretion and can take account of the entire distribution of potential economic outcomes and their effects," Kohn told a conference in Germany.

Since Greenspan also prefers flexibility, there is little chance of a change under his watch, which is due to end on January 31, 2006, when his term expires.

Both camps agree the pursuit of an implicit inflation target between 1-2 per cent for core inflation has helped the Fed achieve sustained price stability.

Regime change

But the new chairman will still have to earn his/her anti-inflation credentials, a challenge Greenspan also faced when he succeeded Paul Volcker in 1987.

"Greenspan's influence grew over time," St. Louis Fed Bank President William Poole said at last week's conference.

He added the Fed chief's deft handling of the October stock market crash shortly after he took the Fed's helm helped the new chairman cement his reputation.

Although the debate seems academic, Fed insiders say with Greenspan's impending departure the issue has significant long-term implications.

"Maintaining institutional credibility during a time of regime change is one of the most important things for the Fed to be talking about at the moment," said the research head of one regional Fed bank, who declined to be identified.

A strong Fed consensus that inflation is damaging and must be controlled has underpinned low US long-term interest rates in a vote of confidence from financial markets.

Still, there is no explicit reason why the Fed should keep to this path, beyond the fact it says it will - a promise that has been good enough for the last 20 years.

Unlike the Bank of England or the European Central Bank, which has aims for inflation close to, but below, 2 per cent, the Fed has not openly stated a specific price stability target.

Instead, it follows long-time goals to deliver price stability and full employment, with no measure of what these add up to in actual numbers.

This means there is nothing on paper to prevent a future Fed under a new chairman from a change in tack.

Times change

Plus, times do change.

The benefits of allowing a bit more inflation - for example in the face of a towering US budget deficit - may not sound so far-fetched in a few years' time, at least to a bond market pondering life after Greenspan.

Advocates of inflation targetting want to lock in Greenspan's credibility by adopting a numerical target, although Bernanke said the bank's track record would survive a change in chairman.

His comments implied there was no need to rush.

"Today, we have personal credibility and a record of success and commitment that creates institutional credibility. Whenever a new chairman comes in, I do not think institutional credibility will be dissipated," he said.

What matters more is where Greenspan's eventual successor stands in the debate.

A Republican administration may call upon Martin Feldstein or Glenn Hubbard, both former chairman of the Council of Economic Advisers, or Treasury Department Undersecretary John Taylor.

Feldstein made plain at the Kansas City Fed's annual conference last year that while specific price goals may be appropriate for some central banks, the Fed was not among them.

"The desirability of adopting an explicit numerical inflation target depends on the need to do so in order to achieve inflation credibility," he said.

"I believe the Federal Reserve has now earned that credibility."

Taylor wrote an influential central banking rule that says real short-term interest rates should be determined by inputs that include the central bank's desired level of inflation, suggesting support for an implicit if not an explicit target.

For the Democrats, former Treasury secretaries Robert Rubin and Lawrence Summers are seen in the running, with former Fed Governor Alan Blinder another contender.

Rubin and Summers have not spoken on the issue recently, but Blinder has said he is in favour.

"I think they should embrace a numerical inflation target without becoming an explicit inflation target. That would be consistent under US law," he said.

Agencies via Xinhua

(Business Weekly 10/26/2004 page6)