MNI INTERVIEW: Ex-Fed Wilcox Favors Inflation Make-Up Strategy

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve should make up for periods of low

inflation by encouraging high inflation later, abandoning its implicit policy of

"letting bygones be bygones" on past inflation misses, former Fed Board research

director David Wilcox said in an interview.

     "We're currently at or near a cyclical peak, and yet the policy rate is

still only 2.25% to 2.5%. That's uncomfortably limited," said Wilcox, who

retired at the end of 2018 after 30 years at the Fed. "I hope they will take

steps to create more policy space for themselves."

     Low interest rates leave the Fed with less room to ease in a downturn and

raise the possibility that policymakers have to keep rates near zero again for

an extended period. Ten years into the current expansion, inflation has yet to

hit the Fed's 2% goal on a sustained basis, adding to fears that low inflation

expectations could become entrenched and reinforce the already weak trend.

     As part of a year-long review of its strategy for achieving maximum

employment and stable prices, officials are debating whether there is a better

method to achieve their 2% target.

     Fed leaders have stressed that any changes to the current symmetric point

target are expected to be "evolutionary not revolutionary," Wilcox noted, and

some form of targeting 2% on average could fit the mold.

     --MAKE-UP STRATEGIES

     Wilcox would advise the FOMC to both raise the inflation target and

eliminate the policy of letting bygones be bygones, though he conceded that

Powell has already publicly ruled out the first option.

     Picking from the menu of inflation make-up strategies that have been

proposed, Wilcox said he has "warmed up" to former Fed Chair Ben Bernanke's

argument in favor of temporary price-level targeting. That strategy would

involve keeping rates lower for longer but only kick in after periods in which

the Fed was forced to cut rates to zero.

     "There's a built-in safety valve in temporary price-level targeting that I

find quite attractive pragmatically," he said. "The key insight in Bernanke's

proposal is that the Fed would be less likely to be in the position of

offsetting a price overshoot when the economy was weak."

     By contrast, with an always-on average inflation targeting framework, if

inflation came in high, "the Fed would have to respond to that surprise by

running the economy cooler than it otherwise would over the makeup period. And I

just worry about the popular support that would have," he said.

     Regardless of which inflation make-up approach the Fed picks, it should

build in a realistic amount of time for monetary policy to affect inflation,

Wilcox said. Anything short of a three-to-five-year horizon "would require,

given how unresponsive inflation is to the cyclical condition of the economy, an

enormous adjustment in the cyclical position of the economy to offset a given

miss in inflation."

     --250 BPS SHORT

     Wilcox estimates the Fed is roughly 250 basis points short of policy space

to fight the next recession. The central bank cut its policy rate by at least

500 bps in each of the past three downturns, not to mention that it would have

cut by much more in the Great Recession if more room had been available.

     What's more, long-term rates are low as well. With the 10-year Treasury

trading near 2%, that potentially leaves little room to boost the economy using

balance sheet or other tools.

     "My guess is half of the current 200 bps (on the longer-term rate) might

disappear just on conventional actions. That leaves only about 100 bps or so of

room, at most, to deliver support to the economy through previously

nonconventional techniques such as forward guidance or (large-scale asset

purchases)," he said.

     Raising the inflation target to 3% would buy policymakers another 100 bps

of ammunition on nominal rates -- "another meaningful step," Wilcox said.

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

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