- Can Adjust Pace, Duration of Bond Buys If Decide Need More Accommodation
- Not Concerned About Rising Bond Yields If Reflect Stronger Recovery
- Don’t Raise Funds Rate Until Inflation Overshoots 2%, Averages 2%
By Steven K. Beckner
(MaceNews) – Chicago Federal Reserve Bank President Charles Evans suggested Monday that, as far as he’s concerned, it would not be appropriate to make adjustments to the Fed’s asset purchase program until spring.
Evans, a 2021 voting member of the Fed’s policy-making Federal Open Market Committee, said that at that time the Fed would be better able to ascertain the strength of the recovery from Covid-related shutdowns and decide whether the pace or duration of bond purchases needs to be adjusted. For now, he said monetary policy is “well-positioned,” although more fiscal stimulus would be welcome.
If bond yields rise, that should not be a great concern, provided they reflect economic strength, he
told reporters following a speech to the National Association for Business Economics at the annual (virtual) meetings of the Allied Social Sciences Association.
But Evans said he and his fellow policy-makers must be “full-throated” about their commitment to keeping the federal funds rate very low and monetary policy in general highly accommodative until inflation not only reaches the 2% target, but exceeds it.
Earlier, in remarks prepared for delivery to the NABE, Evans stressed the Fed needs to lean hard against what he called a “downward bias” to inflation and inflation expectations if it is to achieve its “maximum employment” and average 2% inflation goals. He said the Fed will need to keep monetary policy very accommodative – in terms of both short-term interest rates and asset purchases – “for a long time.”
Even after it lifts off from the effective (zero) lower bound (ELB), he said the Fed should raise rates “slowly” to guarantee it achieves a “moderate overshooting” of the Fed’s 2% inflation target to compensate for years of undershooting. He said the Fed can always raise rates faster if inflation surprises to the upside, but made clear he regards that as unlikely.
Evans was making the first major monetary policy comments since Dec. 16, when the FOMC left the federal funds rate in a zero to 25 basis point target range and again used forceful forward guidance to signal it will hold it there indefinitely. It wants to “achieve inflation moderately above 2% for some time so that inflation averages 2% over time and longer-term inflation expectations remain well anchored at 2%.”
The FOMC “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% and is on track to moderately exceed 2% for some time.”
To “sustain smooth market functioning and help foster accommodative financial conditions,” the FOMC also reaffirmed it will buy “at least” $120 billion per month of bonds.
In a significant communications departure, the FOMC signaled it will keep expanding its balance sheet aggressively by applying funds-rate style forward guidance to asset purchases. It “will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”
Talking to reporters via Webex, Evans gave no indication he is ready to vote for changing the pace of asset purchases or altering their composition, although he said both are eventual possibilities.
Evans said monetary policy is now “well-positioned,” but “as we get to spring” (the FOMC will need to decide “whether need additional commentary about asset purchases.”
Asked to define what “substantial further progress” meant relative to asset purchases, Evans described it as a “ qualitative characterization” and said it is “very difficult to come up a quantitative characterization that would be robust and agreeable to a large number of people.”
But Evans said “our current way of doing $120 billion every month is reasonable across a wide range of maturities.”
“If we see a need for more accommodation we could adjust the current pace or (go to) longer duration,” he added.
On the other hand, if the recovery proves stronger and unemployment lower than expected by the end of the year, he said the FOMC could decide “maybe we need less of this.”
Evans indicated a rise in bond yields would not necessarily induce changes in the asset purchase program.
Although the 10-year Treasury note yield has crept closer to 1%, it was “substantially more” before the pandemic, he noted, adding that “as the economy continues to recover, it is only natural for real rates to go up and 10-year rate to go up with it as well.” So higher yields would be “a reflection of a stronger economy …. I wouldn’t be surprised by further increases.”
He responded similarly to an audience question, saying that “to an extent I look forward to rates going up .… It would be a sign the economy is stronger.”
Evans was not precise about when or under what conditions the FOMC would begin raising the funds rate, but implied it would be well into the future.
“I don’t expect we’re going to see the federal funds rate increase until we get inflation up to 2%, with the expectation that it’s going to overshoot, and then as the September statement says, we can maintain accommodation as we try to average 2%,” he said in response to audience questions. “That means as we slowly raise the funds rate we can still be accommodative in world where inflation is (muted).”
Evans told reporters he is not concerned that inflation and inflation expectations could rise more than the Fed would like. He said it would be “beneficial” if inflation were to get up to 2 ½% or even 3%, although he said that in the latter case “we’d definitely be talking about how we adjust our monetary policy response.”
Evans said spurring recovery from pandemic-related shutdowns can’t be entirely up to monetary policy. “If we’re going to get unemployment really low, it’s going to require fiscal support,” he said.
Welcoming the recently passed stimulus package, he said it “reinforces” his forecast of 4% GDP growth with unemployment at 5% or lower this year. Evans said he regrets the Fed’s special lending facilities having been “extinguished.” He called that “a negative” for the economy.
In his prepared remarks, Evans struck a quite dovish stance. Because the ELB has become a “persistent feature” of the economy and a “persistent threat” to monetary policy objectives, Evans said a “downward bias to inflation expectations and actual inflation” poses “a serious problem” the Fed must overcome.
“(I)n my view we can’t spend the next five years underrunning our target and just offer up explanations for why bringing inflation up to 2% is so hard,” he said. “Instead, we have to avoid such poor outcomes by using policy strategies that offset this downward bias.”
Evans said the Fed’s new monetary policy framework, adopted last August and implemented at the September FOMC meeting, is designed to achieve this through “flexible inflation targeting.” This involves keeping the federal funds rate near zero, where it’s been since last March, until inflation is “moderately above 2% for some time, while continuing to buy assets at the current pace of $120 billion per month “until substantial further progress” has been made toward the Fed’s inflation and employment goals.
“The new framework recognizes that we should not rush to raise rates and risk ending a vibrant, more inclusive job market unless inflation threatens to become uncomfortably high,” Evans said.
The old Phillips Curve theory that tightening labor markets boost inflation will no longer guide monetary policy, according to Evans. “Importantly, even when rates are low and labor markets appear to be tight, we can’t definitely say policy is accommodative if inflation is still mired below our 2% average objective.”
Fed strategy calls not only for keeping the funds rate near zero until its inflation and job goals are met, but also for “increasing the federal funds rate slowly enough to maintain the accommodation needed to achieve moderate overshooting for some time, so that inflation actually averages 2%,” he said.
For this strategy to work, Evans said there must be “strong confidence that policy will remain sufficiently accommodative to generate these outcomes.”
Given that PCE inflation is projected at just 1.4% this year, Evans said “it likely will take years to get average inflation up to 2%, which means monetary policy will be accommodative for a long
time.”
“This translates into low-for-long policy rates, and indicates that the Fed likely will be continuing our current asset purchase program for a while as well,” he added.
“For me, getting inflation moving up with momentum and delivering rates around 2-1/2 % is important for achieving on our inflation objective in as timely a manner as possible …,” Evans said
As a matter of “risk management,” he said “if the actual path of inflation turns out to be higher than expected, monetary policy can always react with higher policy rates to dampen inflation. But if we overestimate the underlying strength of the economy, the ELB could impede our ability to provide adequate interest rate accommodation and achieve our dual mandate goals within a
reasonable amount of time.”
In Evans’ view, “optimal monetary policy under discretion should tilt toward being more accommodative than it otherwise would be and should risk inflation running above 2% for a time….”
“The bottom line is that it will take a long time for average inflation to reach 2%,” he concluded. “To
meet our objectives and manage risks, the Fed’s policy stance will have to be accommodative for quite a while.”
He warned “economic agents should be prepared for a period of very low interest rates and an expansion of our balance sheet as we work to achieve both our dual mandate objective.”
In other comments to reporters, Evans said the Fed regularly monitors financial stability, but said if risks were to appear that should be the province of regulatory policy, not monetary policy.