Powell Ready to Cut Rates to "Effective Lower Bound" via "Conventional" Policy
Let's tune into to statements Powell made today at a "Conference on Monetary Policy Strategy, Tools, and Communications Practices". Emphasis is mine.
I’d like first to say a word about recent developments involving trade negotiations and other matters. We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective. My comments today, like this conference, will focus on longer-run issues that will remain even as the issues of the moment evolve.
While central banks face a challenging environment today, those challenges are not entirely new. In fact, in 1999 the Federal Reserve System hosted a conference titled "Monetary Policy in a Low Inflation Environment." Conference participants discussed new challenges that were emerging after the then-recent victory over the Great Inflation. They focused on many questions posed by low inflation and, in particular, on what unconventional tools a central bank might use to support the economy if interest rates fell to what we now call the effective lower bound (ELB). Even though the Bank of Japan was grappling with the ELB as the conference met, the issue seemed remote for the United States.
The next time policy rates hit the ELB—and there will be a next time—it will not be a surprise. We are now well aware of the challenges the ELB presents, and we have the painful experience of the Global Financial Crisis and its aftermath to guide us. Our obligation to the public we serve is to take those measures now that will put us in the best position deal with our next encounter with the ELB. And with the economy growing, unemployment low, and inflation low and stable, this is the right time to engage the public broadly on these topics.
For a reference point, at the time of the 1999 conference, the United States was eight years into an expansion; core inflation was 1.4 percent, and the unemployment rate was 4.1 percent—not so different from today. Macroeconomists were puzzling over the flatness of the Phillips curve, the level of the natural rate of unemployment, and a possible acceleration in productivity growth—questions that are also with us today.
The big difference between then and now is that the federal funds rate was 5.2 percent—which, to underscore the point, put the rate 20 quarter-point rate cuts away from the ELB. Since then, standard estimates of the longer-run normal or neutral rate of interest have declined between 2 and 3 percentage points, and some argue that the effective decline is even larger.6 The combination of lower real interest rates and low inflation translates into lower nominal rates and a much higher likelihood that rates will fall to the ELB in a downturn.
In a lengthy dissertation, Powell discusses three question, not really answering any of them
- Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?
- Are the existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be expanded?
- How can the FOMC's communication of its policy framework and implementation be improved?
Unconventional is No Longer Unconventional
As part of the answer to question number two, Powell openly admitted that the unconventional isn't so unconventional anymore.
Perhaps it is time to retire the term "unconventional" when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in future ELB spells, which we hope will be rare. We now have a significant body of evidence regarding the effectiveness, costs, and risks of these tools, including those used by the FOMC and others tried elsewhere. Our plans must take advantage of this growing understanding as assessments are refined.
Expect the Unexpected
Powell referenced the "Dot Plot" in regards to the question on communication.
A focus on the median forecast amounts to emphasizing what the typical FOMC participant would do if things go as expected. But we have been living in times characterized by large, frequent, unexpected changes in the underlying structure of the economy. In this environment, the most important policy message may be about how the central bank will respond to the unexpected rather than what it will do if there are no surprises. Unfortunately, at times the dot plot has distracted attention from the more important topic of how the FOMC will react to unexpected economic developments. In times of high uncertainty, the median dot might best be thought of as the least unlikely outcome.
Least Unlikely in Pictures
For a discussion of the "least unlikely" setup, please consider Dot Plot Fantasyland Flashback vs Current Rate Cut Expectations.
Note that the "least unlikely" thing as of the September 26, FOMC meeting was for the Fed to hike interest raters to a median expectation of 3.00 to 3.25%.
Is that comforting?
The entire discussion is ridiculous.
Instead of making the unconventional the conventional and wondering how much to err on the opposite side, how about explaining the absurd reverence to the two percent inflation itself.
We Have Questions
Jerome, you asked but did not answer three questions. And you missed the important ones.
Here's my open letter to the Fed: Hello Jerome Powell, We Have Questions
How about some answers?
Mike "Mish" Shedlock