MNI POLICY: Fed Signals Low Rate Era Needs a Bigger Toolkit

--Former Fed Chairs Say QE, Forward Guidance May Be Enough In Downturn

By Evan Ryser

     SAN DIEGO (MNI) - Changes in the global economy are likely to continue to

hold down interest rates, inflation, and growth in ways that are difficult to

understand and address, current and former Fed policymakers said over the

weekend.

     "We don't have a really good understanding of why it's been so difficult to

get inflation back up," San Francisco Fed President Mary Daly said on a panel on

Friday. "We are going to end up 'fighting inflation from below' without actually

knowing why definitively it's been so low."

     "This new 'fighting inflation from below' is going to be with us, I would

argue, for a longer period of time than just a few years. It's simply not a

cyclical phenomenon," she said.

     New York Fed President John Williams said the long-run structural factors

are global in nature and will be around for years to come, potentially causing

r-star to go even lower due to demographic trends.

     Dallas Fed President Rob Kaplan echoed those comments saying "there have

been substantial structural changes in the U.S. economy since the 80s, and the

90s, and even since the early 2000s" due to technology, globalization, and the

lack of pricing power for businesses.

     This "new world" is presenting a challenge, making it possible to draw more

people into the labor force "experientially," Daly said. At the same time "we

are seeing some early evidence that long-run inflation expectations are

slipping" making it difficult for the Fed to fight a downturn.

     --DEBATE ON COUNTERING LOWER NEUTRAL RATES

     The Fed is in the middle of a review of possible new monetary policy

approaches and the results will be released in mid-2020. The FOMC will not

reaffirm its Longer Run Goals and Monetary Policy Strategy statement, normally

released in January, until the conclusion of its framework review mid-year,

according to minutes from December's meeting released Friday.

     "A new policy framework is likely to be required," Daly said, noting the

Fed needs to consider make-up strategies such as price-level targeting, nominal

income targeting, and average inflation targeting.

     Williams, while speaking on inflation targeting, emphasized the outcome of

the framework review must focus on accountability, transparency, and the

anchoring of inflation expectations.

     While Chair Jerome Powell has ruled out the path to increase the Fed's 2%

inflation objective, Fed policymakers emphasized the need for a larger monetary

buffer. "Most importantly, and this I want to underscore, 2% really can't be a

ceiling," Daly said.

     "We definitely need more policy space," she said.

     Daly said forward guidance and QE may be needed again in the case of a

downturn, "not as a first defense but certainly something to have in our

toolkit."

     --FORMER FED CHAIRS WEIGH IN

     Former Fed Chair Ben Bernanke said in a blog post and paper accompanying a

lecture that QE and forward guidance are effective and can provide the

equivalent of about 3 additional percentage points of rate cuts. That would be

enough to fight a potential recession, assuming the nominal neutral interest

rate does not fall further to below 2%.

     The Fed should also consider maintaining "constructive ambiguity" about the

future use of negative short-term rates, Bernanke said, and the use of yield

curve control at a shorter horizon than used by the Bank of Japan, say two

years.

     "The case for adding the new tools to the standard central bank toolkit

thus seems clear," Bernanke said. "In this case, increasing the inflation target

seems unnecessary."

     Former Fed Chair Janet Yellen agreed with Bernanke's "general conclusion,"

but added that it could be insufficient as rates would already be low and

lower-for-longer monetary policy "could lack full credibility."

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

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