Fed's Kohn-inflation goals stabilize expectations

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WASHINGTON/FRANKFURT, Sep 21 (Reuters) Federal Reserve Vice Chairman Donald Kohn, who has opposed setting inflation targets at the U.S.

central bank, said on Friday that such goals can hold expectations steady and give workers and businesses more certainty about the course of inflation.

''Evidence has accumulated to suggest that stock prices, interest rates, and measures of inflation expectations seem to vary less in economies in which the central bank has an explicit long-run goal for inflation,'' he told a conference in Gernany.

Kohn sought to dispel any notion that he has changed his mind on inflation targeting, a policy approach Fed Chairman Ben Bernanke has endorsed.

''Before anyone jumps to the conclusion that Frankfurt is a stop on my road to Damascus, let this Saul state that for me the case remains open,'' Kohn said, using biblical references at an event marking the 50th anniversary of Germany's Bundesbank -- which has a strong history of fighting inflation.

Unlike many of its fellow central banks, the Fed has no formal inflation target. However, Kohn listed several benefits of setting explicit goals for inflation. A formal target represents a national embrace of a goal and publicly establishes the priority of maintaining price stability, he said.

The Fed has been discussing whether or not to adopt an explicit inflation goal as part of a review of its efforts to communicate more clearly to the public.

Kohn's comments, which were also made available to reporters in Washington, appear to signal growing momentum behind some form of inflation targeting at the Fed.

The Fed vice chairman said the central bank has been discussing ''whether mechanisms could be put in place that could better anchor inflation expectations in a manner consistent with the institutional framework of our dual mandate.'' One benefit of inflation targeting, Kohn said, might be political. ''An important effect of ... public acceptance of price stability is that it erodes the standing of those who would direct central bank action toward other ends,'' he said.

NO BAILOUT Kohn said it was too soon to say what went wrong with the U.S.

housing cycle, which has forced the Fed to shift the principal focus of its concerns from inflation to worries about growth. But he denied this week's 50 basis point cut to interest rates was a bailout for investors.

''The action the Federal Open Market Committee took this Tuesday ... was taken to forestall some of the adverse effects on the global economy that might otherwise arise from the disruptions on financial markets and to promote moderate growth over time,'' he said. ''So it was aimed at the economy, not at bailing people out.'' The swings in the housing cycle had been magnified by inexperience with the market for riskier borrowers, complex and opaque financial instruments intended to disperse risk and fragmented regulatory oversight, Kohn said.

Low short-term interest rates also played a role in inflating the housing bubble.

''Low policy interest rates early in this decade helped feed the initial rise in house prices,'' Kohn said. ''However, the worst excesses in the market probably occurred when short-term rates were already on their way to more normal levels, but longer-term rates were held down by a variety of forces.'' Kohn said the U.S. central bank's dual mandate of fostering maximum employment and stable prices produces results that are not too different in practice from what central banks with flexible inflation targets are able to achieve.

''The dual mandate has come to be interpreted as assigning us the responsibility for attaining price stability in the long run, which will bring with it maximum employment, and of being mindful of resource utilization in a succession of short runs that make up the long run,'' he said.


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