MNI INTERVIEW: Fed May Ease After Review - Ex-Fed's Gagnon

By Pedro Nicolaci da Costa

     WASHINGTON(MNI) - The Federal Reserve's ongoing review of the basic

parameters it uses to gauge monetary policy could force additional interest rate

cuts later this year, a former top Fed economist told MNI.

     Joseph Gagnon, a long-time board staffer who was associate director of the

Fed's Division of Monetary Affairs during the financial crisis, said in an

interview that if the central bank decides to move toward an inflation averaging

system from the current 2% target when its review concludes around mid-year,

that might call for additional stimulus.

     "If the Fed adopts a modest amount of inflation averaging later this year,

it may or may not call for some policy easing depending on the details of the

averaging," Gagnon said.

     "Under the Fed's current strategy, rates are fine and inflation likely to

remain near target. The biggest risk is that coronavirus causes a global

recession. I don't know how likely that risk is."

     Gagnon, who was involved in the design and implementation of the Fed's

first round of large-scale bond buys in late 2008, thinks the Fed will be

missing an opportunity with its framework review by not raising its inflation

target above 2%.

     --HELP WANTED

     He thinks that would help create more room for future easing, given the

restrictions of the zero lower bound on official interest rates, and given that

the fed funds rate is already in a 1.50% to 1.75% range.

     "I think the Fed should dramatically change its strategy and aim for higher

inflation, in which case they need to ease significantly," said Gagnon, now a

fellow at the Peterson Institute for International Economics.

     Such a move, supported by other prominent economists, would have the

additional benefit of making future Fed bond buys more effective, Gagnon's

research suggests.

     Most Wall Street analysts expect the Fed to resort to quantitative easing

or QE in the next downturn.

     The chances of a U.S. recession on the horizon are moderate but not

negligible, Gagnon said.

     "I see roughly a 20% chance of recession striking in the next 12 months.

Add in the possibility of a significant slowdown that is not an outright

recession, and I guess there is a one in three chance that they may ease policy,

but late this year or early next is more likely than early this year because of

the normal lags in collecting and interpreting the data," he said.

     --NOT QE

     The former board staffer was sanguine about the size of the Fed's $4.2

trillion balance sheet, and not concerned that it might limit future bond buys.

     The Fed has been re-expanding its balance sheet since September in an

effort to address disruptions in the repo market.

     "Balance sheet expansion is not QE and has no implications for future QE,"

said Gagnon. "QE requires the purchase of long-term bonds, which they are not

doing."

     The Fed cut interest rates three times in 2019 in a sharp policy reversal

from 2018, when it had raised them four times and promised to keep going. It has

vowed to keep them on hold for the totality of 2020, but markets have already

started to doubt that resolve, pricing in at least one rate cut this year.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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