MNI EXCLUSIVE: Fed May Tweak, Not Transform Strategy In Review

-- Fed Anxiety Builds On Tools To Counter Downturn

By Evan Ryser

     WASHINGTON (MNI) - The Federal Reserve's framework review looks poised to

result in a relatively modest adjustment to its monetary policy toolkit, despite

increasing anxiety among officials over their ability to counter a downturn,

former Fed officials told MNI.

     First announced in November 2018 amid a declining real neutral rate of

interest, an extended period below the 2% inflation target, and limited monetary

policy space in a potential downturn, the review, addressing tools,

communication, and strategy, is due to be wrapped up in mid-2020.

     Despite looking at more ambitious reformulations of its toolkit, such as

targeting price levels or average inflation, the Fed is likely to settle for

re-emphasizing the symmetric nature of its 2% goal, William English, former Fed

Board senior special adviser, said in an interview.

     "I think it'll be a fairly modest adjustment to their framework and then

they will see how it goes and they'll learn," English, now a professor at the

Yale School of Management, said. "I expect them to say something like, 'If we

have undershot our 2% inflation target for a long time we are more willing to

live with inflation above the target for a little while to balance risks.'"

     The Fed may be uneasy about its ability to comply with the demands of a

more ambitious approach, at a time when a flat Phillips curve shows a subdued

relation between levels of inflation and unemployment, according to English.

     "I don't think they'll come out with price-level targeting, but rather

something kind of incremental. Take a step and then maybe take another step

later on," he said.

     --INADEQUATE TOOLKIT

     But, while the Fed might also be worried about generating uncertainty and

other unintended consequences with an over-ambitious policy reform, former

officials acknowledged the potential inadequacy of the existing toolkit in the

current circumstances. With the policy rate only a little over 1.5%, a steep

recession could quickly push the Fed to the zero bound, as well as to

quantitative easing and the use of forward guidance.

     "If it's not a majority view, I think it's at least a substantial minority

concern, that absent some sort of fiscal option, monetary policy alone may not

be enough to handle a significant downturn," Jeremy Stein, former Fed Board

governor from 2012 to 2014 and now professor at Harvard University, told MNI.

     In a recent note Michael Kiley, a Fed Board economist, indicated a similar

concern over the Fed's ability to fight future slumps. Kiley sees "the

possibility that a recession in the United States would bring nominal interest

rates to unprecedented levels, potentially implying limits on the ability of

monetary policy to support a recovery."

     Fed officials have nonetheless expressed concerns about a mechanistic

approach and being bound by strategies such as price-level targeting and hard

average inflation targeting that would require lower for longer policies in a

slump. Dallas Fed President Rob Kaplan has said: "The only thing I am not

willing to do is make forward commitments on what action we are going to take in

the future based on the analytic."

     Minneapolis Fed President Neel Kashkari, among the most dovish members of

the FOMC, Friday reportedly distanced himself from a formal average inflation

target, instead preferring to simply emphasize the symmetry of the current 2%

inflation target.

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

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