Though the Federal Reserve has long been averse to creating a specific target for inflation, the new threat of deflation has forced the central bank to rethink this policy.

And although economists don't expect the Fed to create a new rule anytime soon, some believe it is moving in that direction.

" Fed Chief Alan Greenspan has made it clear that he doesn't want an explicit target. But implicitly, the Fed seems to be giving a higher priority to inflation, and is more concerned about it than economic growth," said Stuart Hoffman, chief economist at PNC Financial Services.

That's good news for a couple of reasons. First of all, it suggests that the Fed isn't going to raise rates until it sees real signs that pricing power has returned. So even if the economy does start to pick up this year, any increase in interest rates probably won't come until sometime in 2004, because inflation often takes time to kick in. In addition, economists say the change in focus has helped to increase transparency.

"With or without a numerical inflation target the Fed has clarified its policy framework so that officials have clear guidelines for action," said Morgan Stanley economist Richard Berner. "It makes policy goals easier to get across to the public at large, which increases the odds the Fed will achieve them."

Last week the Fed hinted that it was concerned about its zero-inflation objective, noting that the probability of deflation "exceeds that of a pickup in inflation from its already low level."

For two decades the Fed has eschewed the idea of establishing a fixed inflation target, with officials arguing that it could limit the central bank's flexibility in times of crisis and that there is little proof it actually makes for a more efficient system.

But increasingly, several Fed officials have begun to embrace the idea. Robert Parry, the president of the Federal Reserve Bank of San Francisco, said last November that "the zero-inflation objective is not desirable," because it could mean that the U.S. falls into a deflationary spiral similar to the one seen in Japan. By setting a target for inflation at say, 2%, some pundits believe the Fed would eliminate the possibility of deflation in the future.

Meanwhile, Richmond Fed President Alfred Broaddus has said he favors an explicit target for inflation, noting that it would allow the public to have a clearer understanding of monetary-policy actions by the Fed.

Last week, Stanley Fischer, a leading candidate for president of the Federal Reserve Bank of New York, said targeting inflation is "a good way to conduct monetary policy." And Fed governor Ben Bernanke has long believed that the central bank should define its goals for inflation, noting this would make "our current procedures more explicit and less mysterious to the public."

PNC's Hoffman noted that some of the old arguments against establishing a specific inflation target "don't carry as much weight" today as they once did.

"In the past, when inflation was more of a problem than it is today, there was concern that if you did announce a target, it would take a while to get down there and the market might misinterpret that," he said. "But now we're there, we don't have that transition problem."

Still, he doubts that the central bank will adopt a fixed target anytime soon.

"Under Greenspan it probably will not happen," agreed Kenneth Kim, economist at Stone McCarthy. "But that doesn't mean the debate will stop."

Greenspan has expressed doubts about setting an inflation target, as have other members of the central bank, such as Fed Governor Donald Kohn.

Opponents argue that targeting inflation isn't easily controllable and that policy moves only take effect with a lag, meaning that it isn't immediately apparent whether monetary authorities have been successful in their efforts. This doesn't happen when central banks target money supply growth or an exchange rate. Opponents also argue that a fixed rate of inflation is too rigid.

"It implies there's some rule that tells you how things are going to work out," said Lakshman Achuthan, managing director at the Economy Cycle Research Institute. "But you might end up in a straitjacket where you know you should be easing or tightening, but the rule hasn't triggered yet so you don't do anything ... perhaps against your better judgment."

The European Central Bank, Bank of England and Bank of Canada already use inflation targeting to guide monetary policy, but some say there is no real evidence that their system works any better than the U.S. model. Indeed, some argue that the U.S. has achieved price stability without the help of a fixed inflation rate. Still, the recent move by the Fed has generally been seen as a move toward convergence with other leading central banks around the world.

"Officials have taken an important step towards inflation targeting," said Morgan's Berner. "Now that the Fed has clarified its intent and game plan, policy has a better chance of success."

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