By Steven K. Beckner
ROCHESTER, NY (MNI) – Chicago Federal Reserve Bank President
Charles Evans reiterated his belief Wednesday that the Fed should
provide “substantial” monetary accommodation to counter what he sees as
a dangerous “liquidity trap” and expressed concern that the Fed could
decide to raise interest rates too soon.
Evans, who dissented in favor of additional monetary easing at the
November and December Federal Open Market Committee meetings, did not
say what kind of further stimulus measures he would like to see. But he
reiterated his belief that the Fed’s policymaking body should advertize
its intention to hold the federal funds rate near zero so long as
unemployment remains above 7%, even if inflation rises a percent above
the FOMC’s implicit target to 3%.
Evans, a member of Fed Vice Chairman Janet Yellen’s subcommittee on
communication, hailed the FOMC’s announcement that it will begin this
month to include participants’ three-year forecasts of the federal funds
rate in its quarterly Summary of Economic Projections. He said it will
help the economy by removing uncertainty and allow the public to assess
when the FOMC is likely to begin raising the funds rate.
But he said the FOMC needs to go further and adopt a “framework” or
statement of monetary policy objectives and strategy, that he said
should include a description of how the Fed would react to changes in
key indicators, such as unemployment and inflation.
As things now stand, relative to its “dual mandate,” Evans said in
remarks prepared for delivery to the Rotary Club of Lake Forest and Lake
Bluff, Illinois, “Given the high unemployment rate and low job growth, I
think it is clear that the Fed has fallen short in achieving its goal of
maximum employment.”
And, he added, “With my own view that inflation is likely to run
below this rate (of 2%) over the next few years, I believe we will miss
on our inflation objective as well.”
Evans said he believes “the disappointingly slow growth and
continued high unemployment that we confront today reflects the fact
that we are in … a ‘liquidity trap.'” And he said “a liquidity trap
presents a clear and present danger of a prolonged period of economic
weakness.” He added, “that means a risk of repeating the experience of
the U.S. in the 1930s or that of Japan over the past 20 years.”
He suggested that means the Fed should continue to pump money into
the economy through whatever means necessary.
“The traditional course of action when inflation is below target
and real output is expected to be below potential is to run an
accommodative monetary policy,” he said. “I support such accommodation
today. And I believe the degree of accommodation should be substantial.”
Evans cautioned against premature monetary tightening. “There is a
natural tendency for policymakers to pull back on accommodation too
early before the real rate of interest has fallen to low enough levels,”
he said. “Therefore, it is essential that the Fed clearly commit to a
policy action that is measurable against our goals.”
Evans advocated what he called a “balanced policy approach,” which
he has enunciated before.
“First, this policy would account for the liquidity trap risk by
communicating that we intend to keep the federal funds rate at
exceptionally low levels as long as the unemployment rate is above a 7%
threshold,” he said. “Reductions in the unemployment rate below this
level would represent meaningful progress toward the natural rate of
unemployment and might be a reason to lessen policy accommodation.”
“Second, this policy would account for the risk of higher inflation
that is, we would be committed to pulling back on accommodation if
inflation rises above a particular threshold,” he said, adding that
“this policy’s inflation-safeguard threshold needs to be above our
current 2% inflation objective.”
“My preferred threshold is a forecast of 3% over the medium term,”
he added.
Evans said the policy of including federal funds rate forecasts
with projections of GDP, unemployment and inflation in the SEP can help
in this regard.
“Being more explicit about appropriate policy can clear up a lot of
uncertainty,” he said. “For example, suppose inflation were running
higher than we would like, and the economic projections in the SEP
showed it coming down over the next couple of years.”
“In the absence of information on participants’ policy projections,
the public would not know whether the FOMC thought inflation would
simply come down on its own or whether it thought that a monetary
tightening would be required to reduce inflationary pressures,” he
continued. “Including policy projections will help clarify such
judgments.”
Evans called the new SEP approach “a substantial, first-order
improvement in policy communications,” and he said “this greater clarity
may have significant additional value for improving how the economy
operates.”
“Expectations of the future path for policy and the degree of
uncertainty surrounding those expectations are key determinants of
private borrowing rates and other asset prices,” he explained. “These
play an important role in the spending and saving decisions of
households and businesses. Households and businesses will be able to
make better-informed decisions if they have a clearer notion of future
policy rates; the potential for reduced uncertainty could also lower the
risk premium embedded in longer-term interest rates.”
But more needs to be done, he said.
“The second new communications initiative — a more explicit
consensus framework for monetary policy — is still a work-in-progress,”
he said, before going on to tell his audience what he’d like to see.
“In my view, a framework statement should help clarify what the
dual mandate goals of maximum employment and price stability mean in
terms of measurable economic outcomes,” Evans said. “It should also
convey the extent to which monetary policy can be expected to deliver
particular long-run outcomes. And it should better enable the public to
form expectations about how policy will react to economic disturbances
that move employment and inflation away from levels consistent with the
dual mandate.”
“Our goals of maximum employment and price stability usually are
not in conflict; but when they are, a more explicit framework can
provide a better idea of how the Committee will weigh the relevant costs
and benefits that enter this more difficult decision-making process,” he
said.
Evans said FOMC adoption of an explicit policy framework together
with his inflation and unemployment triggers “can underscore the
distinction between these policy thresholds vs. our longer-run
objectives.”
“In particular, we would convey that the longer-run sustainable
rate of unemployment is substantially lower than the threshold of 7%,
while the inflation threshold of 3% is higher than the longer-run
inflation objective,” he said. “Consequently, even if inflation runs
somewhat above its goal for a while, the public would understand that we
intend to bring inflation down to the goal over time, and hence
longer-run inflation expectations would remain firmly anchored.”
Just including funds rate forecasts in the SEP will be a big step
forward, though, he suggested.
“The communication of policy projections also works well in
conjunction with the thresholds,” he said. “By publishing projections
for future short-term interest rates along with unemployment and
inflation, the public can evaluate the Committee’s thinking about which
combinations of unemployment and inflation will likely lead to a
lift-off of policy rates.”
“In comparing these projections against my thresholds, the public
can evaluate how much more policy accommodation could potentially be
allowed under my proposal,” he went on. “Providing these additional
forecasts enhances transparency and the public’s ability to evaluate
current monetary policy with alternative approaches.”
“And a framework that explicitly clarifies the Committee’s
commitment to both price-stability and achievable real-side mandate
responsibilities will, I believe, often allow monetary policy to respond
more strongly in the medium-term when adverse economic shocks impede
growth and employment,” he added. “Indeed, I think these additional
communications vehicles can provide further clarification and increase
the effectiveness of the types of additional accommodation that I have
advocated in recent months, as well as earlier in 2010.”
** Market News International **
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