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Bullard: Fed Should De-Emphasize Core Inflation

The Federal Reserve should look beyond measures of so-called "core inflation" in order to assess the true impact of rising prices on American households, a top official at the Federal Reserve said Tuesday.

James Bullard, President of the Federal Reserve Bank of St. Louis, argued the FOMC "should de-emphasize core inflation in order to reconnect with households and businesses that experience important price changes every day."

The Fed currently prefers the rate of core consumer prices, stripping out volatile food and energy costs, as its primary inflation gauge.

In perhaps the biggest attack on the Fed favoring core inflation over headline inflation in forming policy, Bullard insisted "the 'core' concept has little theoretical or statistical backing and is very arbitrary."

"Headline inflation is the ultimate objective of monetary policy with respect to prices," Bullard said, noting that these are the prices that households actually pay.

De-emphasizing core would "reconnect the FOMC with American households and businesses who know price changes when they see them."

Because Asia's booming economies will generate massive demand for energy in the coming decades, the Fed runs the risk of understating inflation for many years if they continue to ignore energy prices.

Although inflation remains "quite low," he added, the Fed could help anchor longer term expectations by joining other central banks in adopting explicit targets for headline inflation.

Having an explicit target for headline inflation "would allow discussion of other measures of inflation in the context of a clearly stated ultimate goal with respect to the price side of the dual mandate."

Addressing the outlook for monetary policy, Bullard noted that the FOMC is likely to keep accommodative measures in place following next month's expiration of the Fed's quantitative easing program.

."Past behavior of the FOMC indicates that the Committee sometimes puts policy on hold," he said, suggesting that the policy rate would remain near zero for an extended period.

Also, the Fed's bloated balance sheet would stay at levels as of the time of the decision to go on hold.

A pause "gives the Committee more time to assess economic conditions," Bullard said.

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