NEW YORK – A rate increase “promised date,” which can be manipulated based on economic conditions, could be the primary policy tool when the fed funds rate target is near zero, according to Federal Reserve Bank of St. Louis President James Bullard.
According to some models, Bullard said, the Federal Open Market Committee could influence financial market conditions and provide monetary accommodation by shifting the promised date. He questioned the credibility of such statements.
“If the economy is actually performing quite well at the point in the future where the promise begins to bite, then the Committee may simply abandon the promise and return to normal policy,” he said. “But this behavior, if understood by markets, would cancel out the initial effects of the promise, and so nothing would be accomplished by making the initial promise.”
Bullard worries that “Simply promising to keep the policy rate near-zero for longer and longer periods of time may encourage a Japanese-style outcome in which the policy rate simply remains near zero and markets come to expect a mild rate of deflation,” he said.
Regarding the FOMC’s options for conducting countercyclical monetary policy in a near-zero policy rate environment, Bullard said, “the Fed’s balance sheet policy—outright purchases and sales—is the most natural and effective tool for this purpose.” He added the FOMC should decide on any future asset purchases on a meeting-by-meeting basis and should also indicate the likelihood that it will continue on its current path at the following meeting. The FOMC’s communications tool—which is the main alternative to asset purchases—“has some potential drawbacks,” he said.
“The Committee needs to be able to conduct a systematic countercyclical monetary policy during the period of near-zero policy rates,” Bullard told an audience in New York Monday, according to a statement released by the Fed. He noted, “asset purchases are a potent tool and must be employed carefully” and cited the increase in inflation and inflation expectations during the past year, despite many measures of economic performance indicating a relatively weak economy.
“This [economic performance] suggests that the output gap may have been considerably smaller than previously thought, and perhaps also that the output gap has considerably less influence on inflation than commonly thought,” Bullard said. “The larger influence on actual inflation comes from inflation expectations,” which have tended to be higher over the past year, according to TIPS measures, he noted.
