MNI INTERVIEW: Fed Needs Radical Review as R* Low: Ex-Staffer

--QE And Forward Guidance Are Weak Tools: Eggertsson

By Evan Ryser

     WASHINGTON (MNI) - The Federal Reserve must be aggressive with a policy

review and factor in the likely continued fall in the neutral interest rate,

former New York Fed economist Gauti Eggertsson told MNI.

     "There is ongoing secular decline in r-star that will not revert itself,"

said Eggertsson, who worked in the New York Fed's research department from 2004

to 2012. "I don't think that the plans we have heard up to now about reforming

the framework really take that scenario into account."

     "It would require much more radical changes than what they're talking

about," Eggertsson said, whose 2003 paper with Michael Woodford on optimal

monetary policy at the zero bound has been cited by Fed officials during the

review.

     Policy makers have indicated their findings due around mid-year may embrace

shifting to target average inflation over a period of time instead of a point

estimate. Chair Jerome Powell has stressed the exercise will only touch on how

to implement the dual mandate of full employment and stable prices, not the

underlying goals, suggesting the goal of 2% price gains won't change. 

     --DISAPOINTING START

     "One disappointing aspect of the review is that they seem to have excluded

up front even contemplating increasing the inflation target," Eggertsson said,

pointing to the need for more room to cut rates in the next recession.

     "The target of 2% inflation was decided I think sort of prior to the

problem of the zero lower bound being as pressing as it has been since 2008," he

said.

     The current situation justifies looking at a different inflation target in

an era where lower neutral rates mean the Fed is more likely to hit the zero

lower bound, he said.

     Some Fed officials say rates can go negative and other tools give them

plenty of monetary power if needed. Other investors are also skeptical about the

value of a higher inflation target when the Fed is missing its current goal. 

     --YIELD CURVE CONTROL

     Eggertsson questioned if QE and forward guidance will be as powerful in a

downturn, and whether even yield curve control would deliver a major boost to

the economy. Yield curve control isn't really a separate tool from forward

guidance where the aim is keeping short rates low with the hope that will be

transmitted to long-term rates, Eggertsson said.

     "There may not be much room even to lower longer-term rates. You already

see this in the euro area and in Japan," he said.

     QE and yield curve control really depend on r-star returning to past

levels, he said. 

     "If it doesn't then forward guidance is not going to do a whole lot," he

said. "Long rates are incredibly low and there is not all that much for them to

do in the next recession."

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

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$,M$$CR$,M$$FI$]