–To Be Pondering How Much More Fed Should Do and How
–Concerned that ‘We Might Be In a Liquidity Trap’
By Steven K. Beckner
(MNI) – Chicago Federal Reserve Bank President Charles Evans added
his voice Friday to the chorus of monetary policymakers who are leaning
toward providing additional monetary stimulus.
Evans, who will be a voting member of the Fed’s policymaking
Federal Open Market Committtee next year, said that high unemployment
and subpar inflation are inconsistent with the Fed’s dual mandate.
What’s more, he expressed concern that the U.S. economy may already
be in a “liquidity trap” — a situation in which the Fed can no longer
stimulate the economy through short-term interest rate cuts.
Evans, in remarks prepared for a Bank of France conference in Rome,
said this predicament may call for “unconventional” policy tools such as
quantitative easing and said he will be “pondering” how much more such
stimulus the Fed should provide and how.
Earlier, New York Fed President and FOMC Vice Chairman William
Dudley strongly suggested he is ready to resume quantitative easing if
the economy doesn’t improve “before long.” And Boston Fed President Eric
Rosengren, one of this year’s FOMC voters, gave similar indications in a
Wednesday interview with MNI and in an earlier speech.
Cleveland Fed President Sandra Pianalto, another 2010 voter, was
more guarded Thursday night, saying, “If additional accommodation is
needed, I want to be sure that the framework we employ is an effective
one. I am confident that the Federal Reserve can effectively respond to
evolving economic and financial developments.”
Two other Fed presidents who will be joining Evans in the voting
ranks next year sounded ambivalent about renewed quantitative easing in
Wednesday remarks. Minneapolis’s Kocherlakota said its impact on both
long-term interest rates and inflation expectations would likely be
“muted.” Philadelphia’s Charles Plosser doubted that further reductions
in already low long-term interest rates would have much impact on
employment and indicated he would only support additional asset
purchases “were deflationary expectations to materialize.”
Evans, by contrast, was fairly blunt Friday in showing his
proclivities toward quantitativ easing, although he did not specifcally
advocate increased asset purchases.
“The size of the unemployment gap, combined with the fact that
inflation has been running below the level I consider consistent with
long-term price stability, suggests that it would be desirable to
increase monetary policy accommodation to boost aggregate demand and
achieve our dual mandate,” he said.
But Evans did not yet prejudge the need for additional measures,
asking, “Should the FOMC judge that further monetary policy
accommodation is appropriate based on our economic outlook, what is the
optimal level of additional accommodation and what policy tools should
be employed to deliver the additional stimulus?”
Ordinarily, he said the Fed would cut the federal funds rate, and
he said, “were the current fed funds rate at 3%, my forecast would call
for a substantial decline in the target rate.”
But, of course, the FOMC has held its funds rate target between
zero and 25 basis points since December 2008.
Evans said several versions of the so-called Taylor rule now “call
for negative interest rates.”
Given the Fed’s inability to cut the nominal funds rate below zero,
he said “the current economic environment poses unusual challenges to
policymakers.”
“In assessing the current state of the economy and considering the
optimal policy response, a key issue that concerns me is the possibility
that we might be in a liquidity trap,” he said, citing as evidence the
behavior of firms and households.
Based on business contacts in his midwestern seventh district,
Evans said “executives are very cautious in their outlook and spending
plans. They appear to be content to post strong profits generated by
unprecedented cost-cutting, rather than growing their top-line revenues
by expanding capital investments and hiring.”
“Households are similarly cautious and gun-shy in their spending,”
he said. “Consumers are displaying significant risk aversion. They have
raised their savings rate, even though those savings earn very little
interest income.”
Evans maintained “these are the classic symptoms associated with a
liquidity trap: the supply of savings that outstrip the demand for
investment even when short-term nominal rates are at zero.”
He said “the modern economic theory of liquidity traps indicates
that the optimal policy response at zero-bound is to lower the real
interest rate, almost surely by employing unconventional policy tools.”
“Theory also indicates that, in the absence of such policy
stimulus, the factors that generate high risk aversion could very well
stifle a meaningful recovery, keep unemployment high and reinforce
disinflationary pressures — clearly an undesirable equilibrium,” he
added.
Evans stopped short of calling for near-term Q.E., though.
Rather, he said, “in the coming weeks and months, as I assess the
incoming data, update my forecast and deliberate on the best monetary
policy approach, I will be pondering two key issues: How much more
should monetary policy do reduce the shortfalls in meeting our dual
mandate responsibilities for employment and price stability; and what
tools should we use?”
If high unemployment were “structural” — that is if it was due to
such factors has people’s reluctance to look for work because of more
generous unemployment benefits or an unwillingness to move to where jobs
are available — then monetary stimulus would not help, Evans said, But
he doubted that is the case.
Evans said the “natural” rate of unemployment has probably risen
somewhat, but to nowhere near the current 9.6%. So he said additional
monetary stimulus can work to reduce the “very large amount of slack” in
labor markets.
As Dudley was earlier, Evans did not sound very optimistic about
the outlook.
He said there have been “significant improvements” in economic and
financial conditions, but said, “we still have a long road ahead before
we catch up to the level of activity we would have achieved in the
absence of the crisis, or any other shock.”
“Moreover, we appear to have lost some of our forward momentum in
recent months,” he added.
“Looking ahead, I expect output growth will strengthen in 2011 and
2012,” he said. “Nonetheless, the pace of growth I currently anticipate
is quite moderate given the severity of the recession we experienced and
the potential growth rate of output. As a result, I expect the
unemployment rate to remain well above its pre-crisis level over the
next two to three years.”
“Given the current and the anticipated future level of resource
slack and subdued long-term inflation expectations, I also expect
inflation to remain below desirable levels over any reasonable forecast
horizon,” he said.
** Market News International **
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