ST. LOUIS (Reuters) - Sub-par inflation over the past five years has caused a shortfall in the United States economy versus its potential growth path, St Louis Fed President James Bullard said on Wednesday as he fleshed out a proposal for a more dynamic system of setting price increase goals.
Several policymakers are encouraging the U.S. central bank to review its method for controlling inflation and consider a system that makes up for weak inflation in one year by allowing prices to rise more quickly in future years so that the overall level, over time, stays on a set path.
The Fed currently aims to get annual inflation to a rate of 2 percent.
Bullard said the Fed's inability to get inflation to its target over the past five years has allowed a 4.6 percent gap to emerge in where the economy, measured in nominal terms before adjusting for price increases, would have been otherwise.
That amounts to more than $820 billion in an $18 trillion economy, according to Reuters calculations based on Bullard's 4.6 percent figure.
The inflation shortfall since 2012 "has opened up a substantial gap between the actual and desired price level," Bullard said in prepared remarks for a speech to the CFA Society of St. Louis.
To compensate, the Fed would have to allow annual inflation of 2.5 percent for a decade - a sign of just how large the gap has become but also of how aggressive the central bank would have to be in its commitment to make up for it.
One of the criticisms of so-called price-level targeting is that it would require central bankers to not only convince politicians and the public that the higher inflation would improve the economy overall, but also that the level of price increases could be brought seamlessly back into line.
Bullard said shifting to such a system "would likely take a lot of preparation and debate."
Several policymakers are encouraging just such a discussion as Fed Chair Janet Yellen winds down her four-year term and her successor, Jerome Powell, prepares to take over.
(This version of the story corrects to make clear in paragraph 5 that lost output figure is Reuters calculation based on Bullard's 4.6 percent gap comment)
(Reporting by Howard Schneider; Editing by Paul Simao)