NEW YORK – The Fed is not achieving either portion of its dual mandate, Federal Reserve Bank of Chicago President and Chief Executive Officer Charles L. Evans said Wednesday.
Having dissented at recent Federal Open Market Committee meetings, Evans’ disagreement about Fed policy was widely known.
“Given the high unemployment rate and low job growth, I think it is clear that the Fed has fallen short in achieving its goal of maximum employment,” Evans told the Rotary Club of Lake Forest and Lake Bluff, Ill., according to prepared text of his remarks, released by the Fed. “As for the price stability component of our dual mandate, the majority of FOMC participants—including me—judge that our objective is for overall inflation to average 2% over the medium term. With my own view that inflation is likely to run below this rate over the next few years, I believe we will miss on our inflation objective as well.”
Economic recovery is “painstakingly slow,” he said, despite accommodative monetary policy and fiscal stimulus, with real GDP only now rising to its pre-recession peak. “Employment growth is barely enough to keep pace with the natural growth in the labor force and the unemployment rate remains extraordinarily high,” Evans said.
Despite recent positive economic news, Evans noted that we saw positive signs last year that caused forecasters to increase their economic predictions, but circumstances changed and the recovery never progressed.
Also, he noted, the current positive data “ does not mean we are seeing a massive surge in economic activity. The data shows only modest improvement in growth to rates that are near or just somewhat above the economy’s longer-run potential. Moreover, the pace of economic activity needs to accelerate further to boost confidence. After all, we have seen our hopes for a more rapid improvement in the economy dashed several times in this recovery.”
Still, these rates of growth “are not strong enough to make much of a dent in the unemployment rate and other measures of resource slack. Indeed, the FOMC’s latest forecasts are for the unemployment rate to remain above 8-1/2% through 2012 and to fall only to about 8% in 2013.”
And “substantial” risk lies ahead, he warned. “The problems in Europe now loom larger. Careful analysis suggests that the direct impact of slower European growth on U.S. net exports likely would be small. However, there is a risk that substantial financial disruptions in Europe could impinge on the cost and availability of credit in the U.S. or induce a new wave of cautious behavior by households and businesses. If that were to occur, then we could see a larger adverse impact on economic activity in the U.S.,” he said.
Despite this, Evans said, his outlook for real GDP growth is “largely unchanged” from November, and his unemployment rate outlook “is only slightly lower. However, I am concerned about the downside risks.”
Traditionally, “when inflation is below target and real output is expected to be below potential,” accommodative monetary policy is the answer, he said. “I support such accommodation today. And I believe the degree of accommodation should be substantial,” Evans said.
Evans suggested slow growth and high unemployment represent a “liquidity trap,” which he explained as occurring when “real interest rates become ‘trapped’ and may not be able to become negative enough to equilibrate savings and investment.”
A liquidity trap “presents a clear and present danger of a prolonged period of economic weakness,” Evans added. Continued accommodation can vastly improve economic performance.
Holding out the possibility he “could be wrong” about the U.S. being in a liquidity trap, and it could be just an economic malaise reflecting “structural factors” and this could indicate “the economy today is actually functioning close to a new, more dismal productive capacity.”
If that were the case, he said, “further monetary accommodation will only lead to rising inflation without much improvement in unemployment.”
“Although I do not find this structural impediments scenario compelling, as a prudent policymaker, I must at least consider its possibility,” he said. “Without a clearer picture of whether we are in the midst of structural change or a liquidity trap, I favor a monetary policy strategy that balances the two risks of dismally slow growth on the one hand and creeping inflation on the other.”
The prescription Evans suggests is, “The Fed could sharpen its forward guidance by pledging to keep policy rates near zero until one of two events occurs:” either the unemployment rate falls below 7% or inflation rises above a certain level.
“I would argue that this policy’s inflation-safeguard threshold needs to be above our current 2% inflation objective. My preferred threshold is a forecast of 3% over the medium term,” Evans said.
Research, he added, indicates “improved economic performance during a liquidity trap requires the central bank, if necessary, to allow inflation to run higher than its target over the medium term. Such policies can generate the above-trend growth necessary to reduce unemployment and return overall economic activity to its productive potential.”
He emphasized “core inflation reaching 3% is only a risk—and not a certainty,” and “core inflation is likely to remain below 3% even under a policy of extended monetary accommodation. But the economy may behave differently than expected. Still, 3% inflation is a risk that we should be willing to accept.”
The Fed’s move to publish “projections for the appropriate path for the federal funds rate and qualitative information about their outlooks” improves “policy communications, and this greater clarity may have significant additional value for improving how the economy operates.”
The other initiative of the Fed: a more explicit consensus framework for monetary policy, Evans said “is still a work-in-progress,” adding “I am an enthusiastic supporter of these enhancements to Fed transparency.”
