DETROIT (MNI) – The following is the fourth and final section of
the remarks of Chicago Federal Reserve Bank President Charles Evans
Monday, prepared for the Michigan Council on Economic Education on the
topic of “Mandate Responsibilities: Maintaining Credibility during a
Time of Immense Economic Challenges:”

A Proposed Policy

I believe that we can substantially ease the publics concern that
monetary policy will become restrictive in the near to medium term and,
hence, reduce the restraint in expanding economic activity. This can be
done by clearly spelling out in our policy statements the conditionality
of our dual mandate responsibilities. What should such a statement look
like? I think we should consider committing to keep short-term rates at
zero until either the unemployment rate goes below 7 percent or the
outlook for inflation over the medium term goes above 3 percent. Such
policies should enable us to make progress toward our mandated goals.
But if this progress is too slow, then we should move forward with
increased purchases of longer-term securities. We might even consider a
regime in which we reevaluate our progress toward our policy goals and
the rate of purchase of such assets at every FOMC meeting. Let me note
several aspects to this policy conditionality. As I just said, I
subscribe to a 2 percent target for inflation over the long run.
However, given how badly we are doing on our employment mandate, we need
to be willing to take a risk on inflation going modestly higher in the
short run if that is a consequence of polices aimed at lowering
unemployment. With regard to the inflation marker, we have already
experienced unduly low inflation of 1 percent; so against an objective
of 2 percent, 3 percent inflation would be an equivalent policy loss to
what we have already experienced. On the unemployment marker, a decline
to 7 percent would be quite helpful. However, weighed against a
conservative estimate for the natural rate of unemployment of 6 percent,
it still represents a substantial policy loss. Indeed, weighed against a
less conservative long-run estimate of the natural rate, it is a larger
policy loss than that from 3 percent inflation. Accordingly, these
triggers remain quite conservatively tilted in favor of disciplined
inflation performance over enhanced growth and employment, and it would
not be unreasonable to consider an even lower unemployment threshold
before starting policy tightening.

I would also highlight that while I believe that optimal policy
would be consistent with inflation running above our 2 percent target
for some time, this policy does not abandon the 2 percent target for
long-run inflation. Indeed, I would support combining this policy with a
formal statement of 2 percent as our longer-run inflation target in
conjunction with reaffirming our commitment to flexible
inflation-targeting. Furthermore, I see a 3 percent inflation threshold
as a safeguard against inflation running too high for too long and thus
unhinging longer-run inflation expectations. It also is a safeguard
against the kinds of policy errors we made in the 1970s. If potential
output is indeed lower and the natural rate of unemployment higher than
I currently think, then resource pressures would emerge and actual
inflation and the outlook for inflation over the medium term would rise
faster than expected. If this outlook for inflation hit 3 percent before
the unemployment rate falls to 7 percent, then we would begin to tighten
policy.

I understand that some may find such a policy proposal to be hard
to understand, or even risky. But these are not ordinary times we are
in the aftermath of a financial crisis with massive output gaps, with
stubborn debt overhangs and high degrees of household and business
caution that are weighing on economic activity. As Ken Rogoff wrote in a
recent piece in the Financial Times, Any inflation above 2 percent may
seem anathema to those who still remember the anti-inflation wars of the
1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box
measures.” The Fed has done a good deal of thinking out of the box
over the past four years. I think it is time to do some more.

(4 of 4)

** Market News International **

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