Public contingency planning should be part of the Federal Reserve’s strategy going forward, Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, said Tuesday.
“The [Federal Open Market] 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 released by the Fed.
He said some benefits of such a plan are that it eliminates inconsistencies in FOMC actions, and it reduces 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 is “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, some say, “the banks’ excess reserves will serve as kindling for an inflationary fire.” But Kocherlakota said that won’t happen since the Fed can pay interest on bank reserves “to deter banks from using their reserves to create money,” thereby averting inflation.