NEW YORK – Public contingency planning should be part of the Federal Reserve’s strategy going forward, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Tuesday.
“The Committee should provide a public contingency plan—that is, provide clear guidance on how it will respond to a variety of relevant scenarios,” he told the South Dakota Chamber of Commerce, according to prepared text of his remarks, which were released by the Fed.
Some benefits Kocherlakota sees from having a plan: to eliminate inconsistencies, such as those he saw with FOMC actions in August and September; it will reduce policy uncertainty for businesses and consumers.
“No contingency plan can ever be definitive. Inevitably, the FOMC will learn things that it did not expect to learn, and events will occur that it did not expect to occur. And so there may be conditions that force the FOMC to deviate from a chosen plan,” he said. “However, having a public plan, and couching its decisions against the backdrop of that plan, will enhance Federal Reserve transparency, credibility, accountability and consistency.”
Also, Kocherlakota said there’s “ no longer an intrinsic connection between the size of the Fed’s balance sheet and inflation” since “banks have few good lending opportunities, and so they’re not trying to attract deposits. As a result, they are keeping nearly $1.6 trillion of reserves at the Fed in excess of what they need to back their deposits. In other words, banks have the licenses to create money, but are choosing not to do so.”
When the opportunities to lend improve, observers suggest, “the banks’ excess reserves will serve as kindling for an inflationary fire.” However, Kocherlakota says the Congressional act that granted the Federal Reserve the power to pay interest on bank reserves will allow the Fed “to deter banks from using their reserves to create money, and through this mechanism, the Fed can prevent inflation. The Fed’s ability to pay interest on reserves means that the old and familiar link between increased bank reserves and higher inflation has been broken.”
The Fed still has ammunition to fight a stalled economy. FOMC can “put downward pressure on long-term market interest rates in at least two ways. First, it could buy more long-term Treasury securities or securities issued by government-sponsored enterprises like Fannie Mae and Freddie Mac. Second, the Committee could extend its prediction for how long it will keep its target short-term interest rate exceptionally low,” he said. “So, tools—and choices—remain.”
