MNI POLICY: Evans Sees Fed Inflation Overshoot To 2.5%

Chicago Fed President Charles Evans told an MNI event Wednesday interest rates should stay low long enough to generate a period of inflation running 2.5% or faster, and that the focus should not be on bigger bond purchases until there is more clarity on the economic recovery from Covid-19.

"Credibility really requires us to prove out that we can overshoot, and we really don't fear I would say 2.5% inflation" or even a bit faster, Evans said. In contrast, he added, to seek inflation of 2.2% inflation would require "fine tuning" beyond the Fed's capabilities, and would also mean that the target overshoot would have to continue until 2026 to achieve a 2% average.

The Fed's main message is commitment to fully reaching its new long-term framework goals and avoid perceptions that global central banks really see 2% as a ceiling, Evans said. He expressed surprise that the U.S. dollar strengthened Tuesday on his remarks that rates would still be accommodative if the Fed hiked before the 2% average was reached.

"This is the part where I thought I was just reading from the FOMC statement, we have indicated that we are going to keep the federal funds rate at zero to a quarter percent until inflation gets to 2%, we get employment conditions that are like maximum employment, and inflation is on track to exceed 2%," Evans said.

"After that, well, we can begin to raise the funds rate and it will still be accommodative. That's the language in the statement that says the funds rate will be accommodative" as we reach our goals.

QE NOT FOCUS NOW

The Chicago President who joins the FOMC as a voter next year said that he was sympathetic toward his Minneapolis colleague Neel Kashkari who dissented last week seeking an even stronger stimulus pledge.

"We are willing to overshoot," Evans said. "Our September statement is really very accommodative," and the market strongly believes there will be no rate increase through 2023.

Ideally, existing policy and the path of the virus will advance an economic recovery, and that needs time to develop, Evans said. "I don't think additional bond purchases at the moment are the most important thing to be focused on, but when they do become really important, I have no doubt that we will."

Full employment may go beyond just restoring the half-century low unemployment rate of 3.5% seen before the pandemic, Evans said, and policy makers should be willing to test how far things can go. "There is not an unemployment rate that is magical," he said. "We are focused on providing the strongest labor market conditions that we can, and just because unemployment goes down to 3.5%, you know, if inflation is under-running our 2% objective, we can go lower."

MORE COMMITTED

Policy makers must also work to make sure the recovery isn't a K-shaped one where most of the benefits go to richer people while the poor continue to struggle, he said. So far, there are surprising signs of resilience in consumer confidence and the ability of people to meet loan payments, something that bodes well for the stability of the banking system, he said.

More fiscal stimulus perhaps in the order of USD1 trillion would go a long way to keep the recovery going, Evans said.

Unemployment could decline to 5.5% next year in a smooth recovery, but be much higher without fiscal aid, he said. State and local governments account for 11% of U.S. employment and may be forced into layoffs without federal assistance given their own balanced budget laws, he said. "Fiscal policy support and improved public health safety are really the key components."

Fed officials need more time to discuss exactly what path of inflation is workable to support the recovery, said Evans, who has led the Chicago Fed since 2007 and pushed a rule named after him with economic targets that guided the Fed following the global financial crisis.

"We are going to have to have a discussion about what we are really willing to do," he said. "I might put together something that was even more committed to overshooting."