Yesterday, John Williams published a new edition of Economic Letters suggesting a higher inflation target. What can we learn from this publication?
In his latest economic analysis, entitled “Monetary Policy in a Low R-Star World”, San Francisco Fed President John Williams suggests the Fed is considering raising its inflation target which is currently set at a 2-percent annual rate. He argues that central banks must be able to adapt policy to changing economic circumstances and to better cope with a low natural real rate of interest. A higher inflation target would imply a higher nominal interest rates and thereby give monetary policy more room to maneuver (it would allow larger cuts in rates in response to an economic downturn before the zero bound becomes binding). Therefore, Williams echoed Bernanke who said once that he did not see anything magical about targeting 2 percent inflation. Alternatively, the Fed could replace inflation targeting “by a flexible price-level or nominal GDP targeting framework, where the central bank targets a steadily growing level of prices or nominal GDP, rather than the rate of inflation”.
What does Williams’ proposal imply for the gold market? Well, his suggestion should be positive for the yellow metal, as it clearly shows that central banks are helpless in the current environment of low inflation, low interest rates and sluggish economic growth. The conventional monetary policy does not work. Actually, even the “conventional unconventional” measures do not work as the central banks cannot spur inflation and fast economic growth, despite the fact that the recession ended seven years ago. Moreover, as Bernanke pointed out, the change of the target could reduce the credibility of the Fed. And it could also re-anchor inflation expectations as the public might expect soaring inflation after the shift. On the other hand, the U.S. central bank cannot hit 2 percent, so it could have problems with reaching a higher target. In both cases, its credibility should be diminished, which would support the gold prices.
The key takeaway is that San Francisco Fed President John Williams suggests the Fed is considering raising its inflation target which is currently set at a 2-percent annual rate. It is another sign that the FOMC members have been revising its views on some key aspects of the U.S. economy and the effectiveness of the current monetary policies. These shifts will push the FOMC in a dovish direction and will reduce the market odds of interest rate hikes this year. It is positive news for the gold market.
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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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