The best monetary policy to spur the economy would be “reducing the target range for the fed funds rate, not increasing it,” and certainly not increasing the target this year or next, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Thursday.
“The FOMC can achieve its congressionally mandated price and employment goals only by being extraordinarily patient in reducing the level of monetary accommodation,” he said at an event in Minnesota, according to prepared text released by the Fed. “Indeed, to best fulfill its congressional mandates, the Committee should be considering reducing the target range for the fed funds rate, not increasing it.”
While the labor market rallied in 2014, the improvement slowed this year, which led some to suggest labor markets no longer have much room to improve. But, Kocherlakota said, “current and projected low inflation presents strong evidence to the contrary. There is room for more improvement—but we will only achieve those gains if we make the right monetary policy choices.”
While low oil prices are partly responsible for low inflation, even the core rates show “little evidence of inflationary pressures,” with PCE core inflation averaging 1.5% since the start of the recession and having been below 2% on an annual basis for nearly seven years, excluding few months, he said.
Inflation is expected to remain below the Fed’s target for at least 18 to 24 months or more. “In terms of the private sector, the median projection in the August Survey of Professional Forecasters is that PCE inflation will be below 2 percent in 2015, 2016 and 2017,” he noted. While the Federal Reserve Board staff outlook estimated PCE inflation would stay below 2% into the next decade.
These forecasts meet Kocherlakota’s long-standing prediction PCE inflation won’t return to target until 2018 or later.
But rather than bad news, Kocherlakota said low inflation is “a huge opportunity.”
“There would be little or no inflationary cost if the Committee were to aim for the kind of remarkable improvement in labor market conditions that we saw in 2014 by adopting a more accommodative monetary policy stance,” he said. “Of course, at any point in time, there are large uncertainties about the long-run level of employment in the economy. But I see low inflation and the strong labor market improvement in 2014 as being strong pieces of evidence against the hypothesis that the Great Recession caused permanent damage to the U.S. labor force.”
And with no permanent damage to the labor force, 2006 can be a benchmark for employment, he said. Earlier this year, Kocherlakota suggested it would take at least three years of employment growth similar to 2014 to reach the 2006 level.
Kocherlakota said the 2015 jobs slowdown resulted from monetary policy changes. The FOMC announced in mid-2013 it would taper its asset purchase program. “Personally, I interpret this policy change back in 2013 as the onset of what the Committee currently intends to be a long, gradual tightening cycle,” he said. “As I noted earlier, we would typically expect that such a change in monetary policy should affect the economy with a lag of about 18 to 24 months. Viewed through this lens, the slow rate of labor market improvement in 2015 is not all that surprising.”
To stem the slowdown, Kocherlakota suggested the FOMC adopt a more accommodative policy stance. “In particular, I don’t see raising the target range for the fed funds rate above its current low level in 2015 or 2016 as being consistent with the pursuit of the kind of labor market outcomes that we are charged with delivering. Indeed, I would be open to the possibility of reducing the fed funds target funds range even further, as a way of producing better labor market outcomes.”
Based on his outlook, Kocherlakota said, “I believe that it would be appropriate to wait until 2017 to initiate liftoff and then raise the fed funds rate at about 2 percentage points per year. My preferred pace of tightening mirrors the pace of tightening from 2004 to 2006—a pace of tightening that is often seen as gradual. (In fact, some would argue, with the benefit of hindsight, that it was overly gradual.) In response to unanticipated inflationary pressures, the FOMC could simply react as it did in 1994, and raise the fed funds rate more rapidly than this gradual pace.”
