Three ideas for the Fed: seeking new ways to measure inflation.

• Author: Sumerlin, Marc
• Position: Energy supply and demand

As Chairman Bernanke, Governor Kroszner, and Governor Warsh settle into their new positions with the Federal Open Market Committee, much of the debate has centered on whether the Fed will pursue a new strategy of adopting a formal target for inflation. But before moving to a more rigid system, the Fed should first consider whether their favorite definition of inflation is broad enough and whether their informal inflation range is too narrow for our high-productivity world.

High energy prices and high home prices have made mainstream America more skeptical that price stability has been achieved, despite a general view among economists that two decades of disinflation, globalization, and rising credibility at central banks has brought inflation close to zero. There are three ways the new Fed could improve its anti-inflation performance, which would also help bridge the gap between what the Fed sees and what workers often feel. First, the Fed should not treat the lower bound of its inflation reference range of 1 to 2 percent more rigidly than they treat the upper bound. Second, the Fed should adopt a new measure of goods and services inflation that more accurately captures trend inflation. And third, the Fed should incorporate rising asset and commodity prices more actively into its decision-making.

Since the middle of the 1990s, the U.S. economy has been marked by a high rate of productivity growth. Catching this trend before it showed tip in statistics was one of the great successes of the Greenspan Fed. High productivity means that it takes less labor to make the same goods--in other words things gets cheaper. An important question in such an environment is whether the downward pressure on the price of goods should be resisted with extraordinary policies by the central bank.

One argument for such a policy is that deflation provides consumers with an incentive to postpone purchases since the same product will be cheaper in the future. An examination of price data since 1997 shows that the United States has experience with deflation, although it's been concentrated in certain goods. Since the end of 1997, apparel prices have fallen 13 percent in aggregate, but nominal spending on apparel still rose over 34 percent in the same period. Consumer computer prices provide an even starker example. Over the same period, prices fell 89 percent, while nominal spending on computers still rose 56 percent.

If deflation becomes an economy-wide phenomenon...