Fed ‘needs to do more’ to stimulate economy

International - Economy 17.01.2014

The US Federal Reserve was being complacent by planning for years of below-target inflation, warned Minneapolis Fed President in a clarion call for more economic stimulus.

 

“We’re running the risk of being content with inflation running consistently below our target. That’s inappropriate,” said Narayana Kocherlakota, who votes on Fed monetary policy this year, in an interview with the Financial Times. “Right now we’re sitting with an outlook for inflation that even by 2016. . . is not getting back to 2 per cent.”

 

Mr Kocherlakota’s remarks illustrate the growing anxiety about low global inflation that led Christine Lagarde, head of the International Monetary Fund, to warn this week that “rising risks of deflation” could be disastrous for the world’s economic recovery – calling it the “ogre that must be fought decisively”.

 

They also underscore the challenges ahead for incoming chairwoman Janet Yellen, who will take over a Federal Open Market Committee that has begun to slow its monetary easing, but must still deal with a weak economy. Prices are up just 1.5 per cent on a year ago, data on Thursday showed. The Fed targets an annual inflation rate of 2 per cent.

 

Mr Kocherlakota said the Fed should improve its communication about how it will behave once the unemployment rate falls below its existing threshold of 6.5 per cent. He said the pledge made in December of low rates “well past” that point is not sufficient.

 

“The problem with what’s in the statement right now is its going to become increasingly less useful once we fall below 6.5 per cent,” said Mr Kocherlakota. Rather than lower the 6.5 per cent threshold, he said the Fed could bring in new guidance about how it will behave until unemployment hits 5.5 per cent, perhaps with a tighter get out clause on inflation.

 

“We would say we intend to keep the Fed funds rate extraordinarily low in that interval between 6.5 and 5.5 per cent as long as the medium-term outlook for inflation stays sufficiently close to 2 per cent,” he said. “I definitely feel it is important to be numerical about it. Words are always subject, I think, to multiple interpretations.”

Mr Kocherlakota is respected as one of the FOMC members with the deepest background in economics, but he is currently at the dovish extreme of the committee, so Fed policy may not reflect his ideas in the short term.

 

Mr Kocherlakota said he would not refight the Fed’s decision to taper asset purchases by about $10bn a month. “My point is simply we need to do more. If the committee chose to do that through more asset purchases that’d be fine with me. But we have to be doing more.”

 

Another policy option would be to cut the interest that the Fed pays to banks on their reserves from the existing level of 25 basis points. Mr Kocherlakota said he would even be interested in making that return negative.

 

“Doing something as surprising and drastic as cutting interest on excess reserves below zero – I think that would be a very powerful signal of the seriousness with which we take the 2 per cent target for inflation,” he said.

 

Mr Kocherlakota said he expects the worlds-largest economy to expand around 3 per cent in 2014, with inflation coming in at around 1.5 per cent. “I think the real challenge is on the unemployment front and forecasting that given what’s happening with labour force participation,” he said.

But before changing policy because of the slide in participation, “you’d want to be seeing evidence that what’s going on the employment side was putting upward pressure on inflation,” Mr Kocherlakota said. Where you’d start to see that is in wage data. Even in the [Minneapolis] ninth district – which arguably has one of the healthiest labour markets in the country – we’re just not seeing evidence of significant wage pressures.”

 

The Minneapolis Fed was recently hit by turmoil that led to the departure of two top economists from its research department but Mr Kocherlakota declined to comment on personnel matters.

    

 

Source : FT

 

 

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