Change is always difficult, and the Federal Reserve’s attempt to find a better monetary policy framework is no exception.
Based on comments by Fed officials at the Hoover Institution conference on Friday, ahead of a confab at the Chicago Fed next month, it seems there may not be a perfect framework, making it difficult to move from the current inflation targeting system.
While “alternative frameworks have theoretical appeal, none of them is without implementation challenges,” Federal Reserve Bank of Cleveland President Loretta Mester said, according to prepared text of her presentation released by the Fed. Now that the Federal Open Market Committee has ruled out the possibility of raising the inflation target above 2%, she said it will consider price-level targeting or nominal GDP targeting, using an inflation average, or setting a “temporary price-level targeting (which is essentially doing inflation targeting in normal times and price-level targeting once the policy rate is constrained by the zero lower bound).”
Another possibility, which hasn’t received as much attention, is using a target range for inflation, rather than a single point, Mester said.
While these frameworks work in theory, Mester said, “Whether these assumptions would hold in practice is an open question.” And if the Fed does change its strategy, she said, communication “will be an essential component of the framework.”
Another drawback, according to Peter Ireland, a professor of economics at Boston College, is “all these strategies, as promising as they may be … require the Fed to accomplish even more in terms of its ability to control the trajectory for inflation.”
The panel is most worried about stimulating the economy when the fed funds rate target hits zerom he said. “The fact that, despite all their efforts, inflation has run consistently, though modestly, below the Committee's 2% target over most of the decade since the financial crisis confirms this.”
Praising the officials for analyzing “the pros and cons of each of these strategies with reference to both specific, quantitative models and to economic intuition and plain common sense,” Ireland called Mester’s push “for more openness and transparency about the limits of FOMC projections, and her advocacy of referencing simple rules that make clear that the Committee's uncertainty about the path of the economy also implies uncertainty about the path for interest rates, powerful and refreshing.”
Federal Reserve Bank of Chicago President Charles Evans told the conference, “The alternative frameworks can require policymakers to commit to provide extraordinary accommodation not only during [zero lower bound] episodes, but also afterward. Policy prescriptions from simple rules are inadequate.”
These policies, he said, could force the Fed to commit to above or below target inflation for “potentially protracted … periods” to make up for misses on the target. Given the current inflation situation, where the target has been missed for almost a decade, it would need inflation to average 3.5% for two years or 2.7% for six years to “close the gap.”
Because interest rates are so low, zero lower bound will be more common, as will use of unconventional tools, such as quantitative easing and forward guidance.
Federal Reserve Bank of St. Louis President James Bullard’s presentation suggested “nominal GDP targeting constitutes ‘optimal monetary policy for the masses’ in this environment.”
“I found [Federal Reserve Bank of Dallas President] Rob Kaplan's points quite useful too,” BC’s Ireland said. “As Rob suggested and Mike Bordo confirmed with his comment from the floor, some of the low inflation we've seen in recent years surely reflects the impact of favorable trends in competitiveness of markets for consumer goods; to the extent that is true, the slower inflation is good news for consumers, and not necessarily something the Fed should fight against.”
In other news, Federal Reserve Bank of Philadelphia President Patrick Harker said he hasn’t altered his medium-term inflation forecast. "I suspect some of the recent weakness is transitory," Harker said. "So I still see it running slightly above our 2% target for the medium term, but that projection is nowhere near written in stone; more like a dry-erase board.
“If any component of the outlook were to affect my view on the appropriate path of monetary policy, it would be inflation,” he said according to prepared text of his Monday speech in Philadelphia, released by the Fed. “However, we’re not there yet, and it would take more data to convince me. I therefore continue to see one increase at most this year; possibly one, at most, next.”
Payden & Rygel Chief Economist Jeffrey Cleveland pointed out the bond market is pricing in 36 basis points of cuts over the next 12 months. "We disagree," he said. "Bond traders are a) too worried about growth/'the end of the cycle' and b) too worried about 'low inflation.' If the data evolve as we expect, the bond market and the Fed will change their collective tune."
Dr. Michael Dooley, chief cconomist, at Figure, said if the Fed makes any change in the framework “it is a big deal” that “would generate a spike in long rates. My guess right now is that this is useful talk but not much chance of action.”
Economic indicators
The Conference Board’s Employment Trends Index inched up to 110.79 in April from 110.73 in March. Gad Levanon, chief economist, North America, for the firm, said, “[T]he behavior of the ETI in recent months suggests that employment will grow more slowly in the coming quarters than it did in the past year, which is to be expected in such a tight labor market. The labor market will continue to tighten, and in such an environment the Federal Reserve is unlikely to cut rates in 2019.”
