This week’s news that US core inflation came in lower than expected in July has increased the likelihood that the US Federal Reserve will keep interest rates on hold for the rest of this year. True, there may be some boost in the form of inflation emanating from China, where producer prices have recently shown strength. But the Fed and other central banks face a structural predicament from which they will not escape via an increase in import prices.
An apparent slow drift down in the natural rate of interest and trend growth across nations means a lower long-term level of policy rates, less room to cut during recessions and the need to resort to extraordinary and possibly distorting measures such as quantitative easing.
John Williams, president of the San Francisco Federal Reserve, this week posited a solution: that the Fed might increase its inflation target, allowing the economy to run faster than otherwise and pushing interest rates higher. This would allow bigger cuts in rates during recessions.