The federal funds rate target should remain at the zero lower bound until inflation reaches 2% and remains headed higher, Federal Reserve Bank of Chicago President Charles Evans said Monday.
“Now is not the time to employ a plan to tighten preemptively on the basis of a forecast,” Evans told the National Association for Business Economics’ annual meeting, according to prepared text released by the Fed. “And our current forward guidance regarding liftoff rejects this tactic. The guidance is pretty straightforward: Inflation should be at 2% and confidently on track for overshooting before we liftoff from the [effective lower bound].”
The Federal Open Market Committee will need to be patient and wait until it reaches its goals before lifting rates, he said. “Of course, forecasts always are in play — that is the nature of the game, given the fact that monetary policy works with a lag. But forecasts come with obvious risks, and moving policy on them should be done with careful risk-management calculus in mind.”
Further, he said, being tired of rates being near zero shouldn’t push policymakers. “Simply saying the federal funds rate has been at zero for a long time is not a good argument for increasing rates.”
To raise inflation expectations, Evans said, “the FOMC needs to follow through on averaging 2% inflation,” which means inflation above 2% for a time, “and we can’t be timid about doing so.”
Evans sees unemployment declining steadily, falling to 4% in 2023, with persistent 2% inflation that same year, then “moderately overshooting 2% over the following few years,” much in line with the most recent Summary of Economic Projections.
His projections, he added, is based on “additional federal fiscal policy actions” soon. “Without adequate fiscal support before too long, I am concerned that recessionary dynamics will gain more traction and lead to a slower trajectory back to maximum employment.”
Turning to the Fed’s new long-run strategy, Evans said, “the biggest impetus for updating our monetary policy strategy was the undeniable realization that the ELB on the federal funds rate was not just an anomaly we stumbled into during the Great Financial Crisis, but a persistent threat to the achievement of our dual mandate goals.”
The monetary policy decisions from 2015-18 taught Evans: “Following a prolonged period of underrunning 2% inflation, tightening on an inflation forecast comes with asymmetric risks; namely, the costs are larger when uncertainties are resolved adversely.”
Also, with a miss to the downside on inflation for years, he said, “something more dramatic than what was in the 2015–18 dot plots and forward guidance was likely needed to boost inflation sustainably. Those didn’t do the trick.”
As for how the new policy would have played out in those years, Evans said, “there would have been a strategic emphasis on producing inflation above 2% for a time in order to offset this shortfall. It’s highly likely that this strategy would have forestalled raising rates in 2015 and 2016; whether inflation would have persistently reached 2% and justified a rate increase sometime in 2017 under this counterfactual is open to debate.”
Additionally, the FOMC would have not been concerned by the low unemployment rate, “if it wasn’t producing undesired inflationary pressure” and wouldn’t have felt it constrained pursuit of inflation above 2%.
“And finally, a looser policy would have made the real economy more resilient to the headwinds that hit in 2018 and 2019,” he said. “It is likely that under the alternative policy, those just-at-2%-inflation numbers in 2018 would have been turned into a meaningful overshoot, providing a buffer to keep inflation from falling as much below target as it did with the disinflationary shock in 2019.”
Separately, the Conference Board Employment Trends Index rose to 54.80 in September from an upwardly revised 53.30 in August.
“Over the last two months its gains have been more modest, indicating that job growth may be slowing down,” according to Gad Levanon, head of its Labor Markets Institute. “The labor market has rebounded better than expected, but with the virus still proliferating, it will not be able to return to its full capacity any time soon.”
Also released Monday, the Institute for Supply Management’s non-manufacturing PMI index rose to 57.8 in September from 56.9 in August. The business activity index rose to 63.0 from 62.4.
Economists polled by IFR Markets expected a 56.3 PMI read.
