By Steven K. Beckner
(MaceNews) – Top Federal Reserve policy-makers continue to strongly signal their long-range intention to maintain an ultra-easy monetary policy, even as they acknowledge that the economy is recovering faster than they expected from the Covid shutdown induced recession.
The Fed’s commitment to a highly accommodative policy is not completely open-ended, but senior members of its policy-making Federal Open Market Committee continue to make clear that it will take a lot to convince them to move up from the zero lower bound, where they have held the federal funds rate since March.
The latest Fed leader to weigh in, Wednesday morning, was Vice Chairman Richard Clarida, who explained to the Institute for International Finance how and why the FOMC revised its “forward guidance” to reflect the August revamping of its Statement on Longer-Run Goals and Monetary Policy Strategy.
Echoing what Chairman Jerome Powell, New York Fed President John Williams and others had previously said, Clarida left no doubt the Fed has left behind its longstanding bent of tightening credit whenever tightening labor markets seemed to portend economic “overheating” and inflation pressures.
That new framework not only switched the Fed’s “price stability” focus from 2% inflation to 2% “average” inflation, it redefined its “maximum employment” objective by declaring that henceforth it would be informed by “assessments of the shortfalls of employment from its maximum level.” Previously, the statement had referred to “deviations from its maximum levels.”
On Sept. 16, the FOMC moved to “outcome-based forward guidance” to reflect those revised goals, announcing that it would “aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.”
“The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved,” the FOMC policy statement went on. “The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”
Simultaneously, FOMC participants extended their zero to 25 basis point projection at least through the end of 2023.
Clarida said, “this language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels.”
“With regard to our price-stability mandate, while the new statement maintains our definition that the longer-run goal for inflation is 2 percent, it elevates the importance—and the challenge—of keeping inflation expectations well anchored at 2 percent in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate,” Clarida explained.
Clarida added that “in order to anchor expectations at the 2 percent level consistent with price stability, it ‘seeks to achieve inflation that averages 2 percent over time,’ and—in the same sentence—that therefore ‘following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.’”
Echoing Powell, Clarida called the new framework “an evolution from ‘flexible inflation targeting’ to ‘flexible average inflation targeting.’”
Notably, Clarida did not qualify this new understanding of the “dual mandate” by any reference to “financial stability” concerns, which some officials have stressed should be an ancillary Fed goal.
For example, in late September, Dallas Federal Reserve Bank President Robert Kaplan warned “there are real costs to keeping rates at zero for a prolonged period of time.”
“Keeping rates at zero can adversely impact savers, encourage excessive risk taking and create distortions in financial markets,” the FOMC voter continued. “Excessive risk taking an distortions in financial markets could lead to grater fragilities, excesses and imbalances which could ultimately jeopardize the attainment of the Fed’s objectives. These fragilities and tail risks are often much easier to recognize in hindsight than in real time.”
“I believe there are real costs to keeping rates at zero for a prolonged period of time,” Kaplan said. “Keeping rates at zero can adversely impact savers, encourage excessive risk taking and create distortions in financial markets. Excessive risk taking and distortions in financial markets could lead to greater fragilities, excesses and imbalances which could ultimately jeopardize the attainment of the Fed’s objectives. These fragilities and tail risks are often much easier to recognize in hindsight than in real time.”
More recently, Boston Fed President Eric Rosengren cautioned, “If we expect to remain in a low-interest rate environment for a protracted period of time, we need to take more precautions against financial stability risks for when the next economic shock hits.”
San Francisco Fed President Mary Daly did, in fact, bow to financial stability considerations and qualifed the FOMC’s zero rate commitment in a Tuesday speech: “In other words, in the absence of sustained 2 percent inflation or emerging risks, such as to financial stability, we will not take the punch bowl away while some many remain on the economic sidelines.”
But Clarida was faithfully following the lead of his chairman, who on Oct. 6 said “the risks of policy intervention are still asymmetric” to the downside and warned, ‘too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses.”
Indeed, “the risks of overdoing it seem, for now, to be smaller,” said Powell, who has also become an increasingly vocal advocate of additional fiscal stimulus. “Even if policy actions ultimately prove to be greater than needed, they will not go to waste ….”
Chicago Fed President Charles Evans was even more emphatic last week, asserting that the Fed needs to be “in it to win it” and strive for inflation “overshooting.”
“We can’t be timid about doing so,” he added.
While calling for an all-out commitment to jobs and higher inflation, Clarida was quite upbeat about the economy: “This recession was by far the deepest one in postwar history, but it also may go into the record books as the briefest recession in U.S. history. The flow of macrodata received since May has been surprisingly strong .…”
But Clarida added, “It will take some time to return to the levels of economic activity and employment that prevailed at the business cycle peak in February, and additional support from monetary—and likely fiscal—policy will be needed.”