FRANKFURT, Germany — Federal Reserve vice chairman Donald Kohn said Friday that central banks need to show the will and the means to exit non-standard measures.
Changing a central bank’s inflation target is risky, Kohn told an audience at an event honoring outgoing European Central Bank vice president Lucas Papademos.
Kohn said that the anchoring of inflation expectations is even more important as banks approach the zero bound of interest rates.
Exit tools are “very important” for central banks, Kohn said. “You need to know how are you going to raise rates [and] need to show people that you not only have the will, but also the means to do it.”
The Fed is “also developing tools to absorb reserves to back up” any potential increase in interest rates to “make sure that it is effective,” he said.
“It is critical that central banks have the exit strategies in place and are able to explain to the public that they are in place.”
The extra tools that a central bank employs must be dependent on the inflation outlook, according to Kohn.
“I also agree as many have said that central banks need to pay much more attention to indicators of financial imbalances and financial stability,” he said.
With respect to liquidity facilities, Kohn said it’s important to ensure that central banks don’t take on too much tail risk and that more of the risk be taken on by private institutions.
“One lesson is that once the policy rate is at or close to zero, expectations about future policy is even more important than it is when rates have a place to move,” he said.
“Central bank purchases of assets are particularly helpful when markets are illiquid,” Kohn said. “When normal arbitrage is disrupted, we saw that in the U.S., and we are seeing it in Europe today.”
— Market News International