Insiders seek radical policy review under new Fed Chief

New York: Federal Reserve officials are pushing for a potentially radical revamp of the playbook for guiding US monetary policy, hoping to seize a moment of economic calm and leadership change to prepare for the next storm.

While the country is enjoying its third-longest expansion on record, inflation and interest rates are still low, meaning the central bank has little room to ease policy in a downturn before hitting zero again.

With Jerome Powell nominated to take over as Fed chairman in February, influential officials including San Francisco Fed chief John Williams and the Chicago Fed’s Charles Evans have taken the lead in calling for reconsidering policy maker’s 2 per cent inflation target.

“It’s a good time given the shift in leadership,” Atlanta Fed President Raphael Bostic told reporters on Tuesday in Montgomery, Alabama. “The new guy comes in and they are able to really think about, how should this work, how do I think this should work, and is it compatible with where we’ve been and where we are trying to get to?”

Formalised Policy
The Fed in 2012 officially settled on 2 per cent inflation as an explicit target for the price stability half of its dual mandate from Congress. The other goal is maximum sustainable employment.

The move formalised a policy they’d been following in practice for several years, and it was backed by careful logic: 2 per cent is high enough to ensure that workers continue to get raises and to give the Fed some cushion against deflation. Other advanced economies aim for a similar level.

Yet Fed officials have been urging the policy-setting Federal Open Market Committee to revisit that approach.

“I do think that’s a very important thing that we should all be starting to think about, to prepare ourselves and evaluating,” Cleveland Fed President Loretta Mester told a monetary policy conference at the Cato Institute Thursday in Washington. “The Bank of Canada rethinks its framework every five years. It seems to me that’s not a bad thing.”

The reason? The target was settled at a time when officials thought they’d have no problem in lifting interest rates to 2 per centor higher without choking off growth. But fundamentals in the economy have changed since the crisis. Growth and productivity have been tepid.

As a result, the so-called neutral level of interest rates — which neither speeds up or slows the economy — is very low by historic standards, leaving the Fed with less wiggle room.

Allowing prices to rise slightly higher would give the Fed more scope to ease in the next downturn. The federal funds rate is quoted in nominal terms, or not adjusted for inflation. So if neutral stands at 0.5 per cent, in real terms, and prices are rising at a 3 per centpace, the Fed can get rates as high as 3.5 per centbefore policy would be restrictive. If inflation were only 2 per cent, that level in nominal terms would be 2.5 per cent.

Williams told reporters in early November that he favours discussing a new framework now, though he doesn’t want to tie the talks to nearterm strategy.