MNI INTERVIEW:Fed To Avoid More QE Unless Another Shock-Sheard

The Federal Reserve will only go further on asset purchases if the world's largest economy has another significant shock, and more likely will take a long and patient march back to its full employment and inflation goals, former S&P Global Vice Chairman Paul Sheard told MNI.

With the program running at an annual pace approaching USD1.5 trillion and yields already low, further moves will have limited punch, while fiscal policy is better positioned to lift demand, Sheard said. The main options from here would be a faster pace of purchases or yield curve control, perhaps at the 10-year mark, he said.

But policy makers will be more sensitive about reacting to downside risks than positive surprises, given their own projections don't yet show any consensus that core inflation will break through 2% in coming years, he said. Another consideration is the Fed will need to show it's doing something in the event of significant fresh weakness.

"The message, I think, from the Fed and most of the central banks is that we've done pretty much all we could do in this environment, we can kind of tinker around the edges a little bit, we'll continue to do the standard stuff, which is the balance sheet expansion," said Sheard, now at Harvard's Kennedy School. He's also a former visiting Bank of Japan scholar.

FORGET ABOUT FINE TUNING

"If things materially deteriorate, particularly relative to their forecast, they would have to do something," he said, pointing to the possibility of an extended pandemic or weakness in employment or inflation.

"But none of these things are going to be silver bullets," he said. "They are going to be policies that the Fed is kind of forced into taking because it has been seen to do something."

The Fed may also struggle to meet its new inflation framework goal because the pandemic isn't a regular business cycle with a steady trend of prices that it can easily shape, he said. Deeper changes like digitalization of the economy may also change underlying forces like the neutral interest rate, he said.

"There's no way in the world that the Fed can fine tune that kind of thing," Sheard said.

MORE POLICY COOPERATION HELPFUL

Chair Jerome Powell's willingness to break open emergency tools this year mean that Joe Biden and his incoming Treasury Secretary Janet Yellen may see little major gain from seeking to replace him when his term is up, Sheard said. Powell "gets on well with Yellen, he's middle of the road, you don't get a lot by replacing and you actually get a little bit of kudos because you'll have to be a little bit bipartisan," he said.

The U.S. would benefit from a world where "embarrassment" over fiscal and monetary cooperation is replaced by cooperation to tackle a severe crisis, he added.

"That could be a major shift," Sheard said. "Someone like Janet Yellen at the Treasury working with the Fed, I think she could do that in a more critical fashion than perhaps some other people."