Fed Paper: Falling Zero Lower Bound Risk Supports Faster Hikes

By Jean Yung

     WASHINGTON (MNI) - The risk of the U.S. central bank lowering interest

rates to near zero peaked last fall and will decline further in the future, a

development that supports a pick-up in interest rate increases, argues new

research from the Federal Reserve Board. 

     When the economy is expanding after a prolonged period of near-zero rates

-- "like the U.S. economy today" -- a higher effective lower bound risk "calls

for a more gradual increase in the policy rate," senior economist Taisuke Nakata

wrote in a recent FEDS Note posted on the Fed Board website.  

     But he found that the so-called zero lower bound risk, or the risk that the

Fed would have to slash rates to zero again in the next three years, has already

declined from a high of above 50% in the third quarter of 2016 to around 35% in

the second quarter of this year. 

     It is expected to fall further to around 26% by the end of the year as

policymakers get ready to raise rates further, Nakata found after running

stochastic simulations using the Fed's FRB/US model.   

     From their peak levels, "the current (effective lower bound) risk measures

are all more than halfway toward their steady-state values," estimated at

between 16% and 18%, he said. 

     "The extent to which central banks should adopt risk-management approach

depends importantly on how likely the federal funds rate will be constrained by

the ELB in the near- and medium-term future," he wrote. "The model-based

measures of ELB risk considered in this article can be a useful input in

evaluating the stance of monetary policy in the recent past and determining

policy rates in the future." 

     That would seem to support the conclusion that the decline in risk would

bolster the case for less gradual rate hikes. 

     The article does not address unconventional policy tools such as asset

purchases employed by various central banks including the Fed to stimulate the

economy when rates are close to zero. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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