By Steven K. Beckner
HONG KONG (MNI) – Chicago Federal Reserve Bank President Charles
Evans said Monday that the Fed needs to take “even stronger steps” —
namely further asset purchases — to accelerate “anemic” growth and
insulate the economy from potential recession.
What’s more, he said the Fed should be willing to tolerate
inflation as high as 3% to reduce unemployment from 8.3% and said it
should publicly declare that it will keep the federal funds rate near
zero so long as unemployment is above 7%.
Evans, who will return to the voting ranks of the Fed’s
policymaking Federal Open Market Committee next year, expressed a
preference for buying mortgage backed securities in an “open-ended”
fashion in remarks prepared for delivery to a seminar sponsored by MNI.
He said a third round of asset purchases, or “quantitative easing,”
needs to be carried on until the economy improves and should be done in
conjunction with a clarification of the FOMC’s “forward guidance” about
the path of the funds rate.
It would “reassure” markets and the general public if the FOMC were
to make clear that it intends to keep the funds rate near zero even
after the economic growth pace picks up and that it is willing to
tolerate inflation well above the FOMC’s announced 2% target, Evans
argued.
The Fed could stop buying assets once there is clear evidence that
the economy has gained momentum, he said, but should not raise the funds
rate until after the unemployment rate has dropped below 7% — even if
inflation exceeds 2% by as much as a percentage point.
Allowing inflation to go as high as 3% would not be at odds with
the “balanced” approach to fulfilling its statutory “dual mandate” goals
on inflation and employment enunciated on Jan. 25 as part of its
statement of “Longer-Run Goals and Policy Strategy,” Evans insisted.
The Chicago Fed chief serves on an FOMC subcommittee on
communication policy chaired by Vice Chairman Janet Yellen.
His monetary policy advice, which is consistent with what he has
been giving for months, came against the backdrop of a dreary assessment
of economic conditions and prospects.
Even though recent data have had a stronger tone, Evans said
“resource gaps remain huge” because real GDP growth this year “may not
even be enough to keep up with potential.”
“Growth in 2013 is expected to be only moderately higher,” he said.
“Moreover, both the European debt situation and the looming U.S. fiscal
cliff impart substantial downside risks to the forecast.”
“Even absent any negative shocks, such tepid growth rates would
close the large existing resource gaps only very gradually,” Evans
continued. “Indeed, I expect that we will face unemployment well above
sustainable levels for some time to come.”
Evans added that “economic growth is not much above stall speed.”
And he warned, “Another negative shock could send the economy into
recession. And if a recessionary dynamic takes hold, it would be
especially difficult to regain momentum.”
He cited a recent estimate by the Congressional Budget Office that,
if not averted, the automatic tax hikes and spending cuts due to take
effect on Jan. 1, would reduce real GDP growth by about 4 percentage
points in 2013.
With so much economic slack and low inflation expectations, he
said, inflation does not pose a serious threat — or an impediment to
vigorous additional monetary stimulus.
At its June 20 meeting, the FOMC prolonged its “maturity extension
program” or “Operation Twist.” Through year’s end, the Fed will buy $267
billion of longer-term Treasury securities, financed by sales of a like
amount of short-term Treasuries. It also reaffirmed its expectation that
the funds rate will need to stay near zero “at least through late 2014.”
At the July 31-Aug. 1 meeting, the FOMC decided it needed “more
time” to assess the impact of the extended Operation Twist before
deciding to do more, although minutes of the meeting said “many members
judged that additional monetary accommodation would likely be warranted
fairly soon unless incoming information pointed to a sub-stantial and
sustainable strengthening in the pace of the economic recovery.”
Notwithstanding better-looking data received since Aug. 1, Evans
reasserted his calls for immediate, additional monetary stimulus — both
QE3 and enhanced forward guidance.
While calling the second iteration of Operation Twist a “useful
step,” he asserted, “I believe it is time to take even stronger steps,
such as the purchase of more mortgage-backed securities, to increase the
degree of monetary support for the recovery.”
With a bow to colleagues Eric Rosengren and John Williams,
presidents of the Boston and San Francisco Federal Reserve Banks, Evans
said “these could be open-ended purchases, meaning that they would
continue at a certain rate until there was clear evidence of improvement
in economic conditions.”
Evans said such “clear evidence” might mean “a resumption of
relatively steady monthly declines in unemployment for two or three
quarters.”
“Once this momentum was confidently established, the Fed could stop
adding to our balance sheet but keep the funds rate at zero,” he said.
“The funds rate would remain unchanged in my thinking, until the
unemployment rate hit at least 7% or the medium-term inflation outlook
deteriorated dramatically and rose above 3%.”
Evans said the Fed should start shrinking its balance sheet assets
only “sometime after the first increase in the funds rate.”
Expanding the Fed’s balance sheet and thereby increasing bank
reserves — something Operation Twist does not do — is not enough in
Evan’s view, however. Enhanced communication about Fed intentions is
also needed.
“For this liquidity to be sufficiently accommodative, the public
needs to expect that we will keep it in place for as long as is
necessary to restore the economy to a sound footing,” he said. “This is
why I believe we should clarify the Fed’s forward guidance with regard
to the future course of policy.”
Evans said “the best way to provide forward guidance is by tying
our policy actions to explicit measures of economic performance.” And he
reiterated his 7/3 threshold framework which he has been advocating for
the past year.
Announcing that the FOMC won’t raise the funds rate until the
unemployment rate falls below 7% “would reassure markets and the public
that the Fed would not prematurely reduce its accommodation,” he said.
Evans said he does “not expect that such policy would lead to a
major problem with inflation,” but said, “I believe that the commitment
to low rates should be dropped if the outlook for inflation over the
medium term rises above 3%.”
“The economic conditionality in this 7/3 threshold policy would
clarify our forward policy intentions greatly and provide a more
meaningful guide on how long the federal funds rate will remain low,” he
said. “In addition, I would indicate that clear and steady progress
toward stronger growth is essential.”
Evans acknowledged that he has gotten a lot of criticism for his
willingness to tolerate inflation as high as 3%. “Isn’t this blasphemy
for a central banker?” he asked rhetorically.
But he didn’t back down, defending his position on the grounds that
it jibes with the “balanced approach” put forth by the FOMC and
elaborated on by Fed Chairman Ben Bernanke earlier this year.
“As Chairman Bernanke stated at his April press conference, the 2%
inflation goal is a symmetric objective and not a ceiling on inflation,”
Evans said. “Symmetry means that inflation below 2% should be viewed as
the same policy miss as if inflation overran 2% by equal amount.”
The FOMC needs to “take symmetry seriously,” Evans said. “If we
disproportionately recoil at inflation a little above 2% versus a little
below, then we are not symmetrically weighing policy misses. And we will
not average 2% inflation, which is our goal.”
Noting that some FOMC participants have projected that the funds
rate will rise before 2014, even though the FOMC forecast is for
inflation to remain at or below 2% and unemployment to remain above the
long-run objective, he commented, “it’s difficult to see how this is
consistent with a symmetric inflation goal and a balanced approach to
achieving the two legs in our dual mandate.”
So Evans said the FOMC needs to “do better at describing our
thinking with respect to tolerance bands around our long-run inflation
and unemployment goals.”
His preference would be “if we are missing our employment mandate
by a large amount, but are close to our inflation target, then we should
be willing to undertake policies that could substantially reduce the
employment gap even if they run the risk of a modest, transitory rise in
inflation that remains within a reasonable tolerance range of our
target.”
[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]
