Persistent below-target inflation is very costly, especially when it is accompanied by debt overhang, substantial resource slack, and weak growth. In the United States, the challenge of below-target inflation continues to be underappreciated in public commentary. Mistakenly, many greatly exaggerate the risks of overly high inflation. Before turning to inflation risks, let me mention one reason for some confusion. That is, some commentaries minimize the current below-target inflation experience by citing the slightly higher increases of the Consumer Price Index, or CPI. The CPI is the best-known single measure of inflation, and its underlying trend currently is running at a bit above 1–1/2 percent. Many commentators compare the CPI against our 2 percent inflation objective. Unfortunately, this is an apples and oranges comparison: The CPI tends to run about a quarter to a half of a percentage point higher on average than the PCE index because of its different market-basket composition and statistical construction. Accordingly, it is much more accurate to describe the Fed’s inflation objective in terms of the CPI to be roughly 2–1/2 percent. So, against this 2–1/2 percent benchmark, CPI inflation also is quite low relative to target. In any event, the PCE price index is the preferred inflation measure on a number of theoretical grounds and the one chosen by the FOMC as its policy target; therefore, we should judge the Committee’s ultimate inflation performance using that index relative to its 2 percent goal. So, what is the inflation outlook in the current environment?
Also, several thousand experts, including auditors, consultants, appraisers, etc., participated in the exercise and strict quality assurance was enforced both at the level of the national supervisory authorities and by the ECB. The results disclosed yesterday show that European banks have, in the main, a comfortable solvency cushion. A good number of them have been able in recent months to reinforce their solvency levels notably, meaning that the capital measures needed to comply with the requirements arising from the exercise are modest in scope. However, the analysis has shown that some European banks are in a vulnerable solvency position, which they should redress as soon as possible. All told, as important as the solvency assessment the exercise provides is the detailed information furnished on each bank. In particular, the asset quality review offers significant data on the potential shortcomings of the way in which the financial information disclosed by banks reflects the risk they assume. Here it can be seen, once again, that there is no widespread material understatement of risk, in the form of valuation failings or provisioning shortfalls. But there are European banks where the asset review has evidenced shortcomings of some significance. In the case of Spanish banks, the analysis has offered fairly satisfactory results. In particular, the asset quality review situates Spain as the country where fewest failings have been detected in proportion to the sector’s aggregate assets.