MNI BRIEF: Fed Gov Waller: Covid-Era Guidance Too Restrictive

The Fed's forward guidance on when it would begin tightening policy as the U.S. economy recovered from Covid-19 was perhaps too "constraining," Federal Reserve Governor Christopher Waller and Board of Governors economist Jane Ihrig said in an academic note published Wednesday.

The FOMC in December 2020 laid out guidance that the Fed would keep buying USD120 billion per month in securities "until substantial further progress has been made" toward maximum employment and stable prices and would keep rates near zero 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." (See: MNI: Fed Review To Rebalance Inflation Target-Ex-Officials)

Since the FOMC wanted to wind down QE before hiking interest rates, the tapering guidance it set out ultimately led to having to "pivot hard" to accelerate tapering, Waller and Ihrig noted. "One might argue that requiring substantial further progress toward maximum employment to even begin the process of tightening policy locked the Committee into holding the policy rate at the zero lower bound longer than was optimal." The liftoff guidance was similarly restrictive. "A lesson is that perhaps more flexibility should be considered in future liftoff criteria."

By 2021 the FOMC also knew that the path of tightening would need to be quite steep. "Perhaps another lesson is that giving forward guidance about liftoff should also include forward guidance about the possible path of the policy rate after liftoff," Waller and Ihrig said. (See: MNI INTERVIEW: Hot US Economy Complicates Fed Cut Calculus)