NEW YORK – While rules can be attractive when setting monetary policy, they cannot replace analysis, Federal reserve bank of New York President William Dudley said Thursday.
“Despite these attractive features, I do not believe that simple policy rules can take the place of in-depth analysis of economic conditions, evaluation of alternative policy plans, and ultimately policy judgment,” he told the Council on Foreign Relations, according to prepared text of remarks released by the Fed. “While simple policy rules provide useful information to policymakers, their very virtue—simplicity—means they cannot capture all information that is relevant for policymaking. For example, such rules cannot easily incorporate asymmetric risks or financial stability issues.”
There are “substantial advantages” to “behaving in as systematic fashion as possible in setting monetary policy,” he noted, but there must be accommodation for “any constraints on policy imposed by the economic environment, the presence of asymmetric risks, and” it must allow the ability “to learn as we go.”
He noted, there’s no experience to tell us “how the economy is likely to perform” following the recent crisis. “What we need to focus on is not what interest rate a given rule generates, but what policy setting can be expected to deliver the appropriate return path to the dual mandate objectives—the type of return path that standard Taylor Rule formulations achieved in different economic circumstances in the past.”
But Dudley expects the federal funds rate target to “remain exceptionally low—that is at the current level—at least through late 2014.”
He added, “We should focus on how fast we are moving toward our employment and inflation objectives, and be wary of the risks that we see around that path. If progress toward the mandate objectives is slower than desired, then this is telling us that monetary policy needs to be kept at a more accommodative setting for a longer time period than a standard rule would suggest. As downside risks continue to be present, the case for accommodation is even stronger,” he said.
“Given our forecast of stable prices and a still slow path back to full employment, there is an argument for easing further. But, unfortunately, our tools have costs associated with them as well as benefits. Thus, we must weigh these costs against the benefits of further action,” he said.
“As long as the U.S. economy continues to grow sufficiently fast to cut into the nation’s unused economic resources at a meaningful pace, I think the benefits from further action are unlikely to exceed the costs. But if the economy were to slow so that we were no longer making material progress toward full employment, the downside risks to growth were to increase sharply, or if deflation risks were to climb materially, then the benefits of further accommodation would increase in my estimation and this could tilt the balance toward additional easing.”
“Under such circumstances,” he continued, “further balance sheet action might be called for. We could choose between further extension of the duration of the Federal Reserve’s existing Treasury portfolio and another large-scale asset purchase program of Treasuries or agency mortgage-backed securities.”
But, he added, “Conversely, I would be willing to consider tightening policy at a somewhat earlier stage if growth strengthened sufficiently to materially improve the medium-term outlook and substantially reduce tail risks, or if there was evidence of a genuine threat to medium-term inflation, including a rise in inflation expectations. In such a case, I would anticipate that the first step would be to bring in the late 2014 date of the policy guidance. This would effectively tighten financial conditions not only by changing the expected path of short-term interest rates, but also by bringing forward the expected start of balance sheet normalization.”