Regardless of QE’s success, Fed looks for other tools

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Even as Federal Reserve officials and economists continue to tout the success of quantitative easing, they are searching for a better way to combat the next recession, whenever that may be.

While higher-than-expected first-quarter growth has eased the recession worries that had been brought on by flat yield curves, the Fed continues on its quest to assess its toolbox.

The Fed has undertaken a year-long review of its monetary policy framework and communications. Fed Gov. Lael Brainard, speaking at a “Fed Listens” event at the Federal Reserve Bank of Richmond on Wednesday, said policy makers “want to make sure that the way we are setting monetary policy is keeping up with the way the economy is changing.

“For a variety of reasons, it seems likely that equilibrium interest rates will remain low in the future,” she said. “Low interest rates present a challenge for the traditional ways of conducting monetary policy.”

In the past, the Fed would cut rates four or five percentage points to stimulate the economy during a slowdown. With the fed funds rate at a range of 2.25% to 2.5%, if a recession were to occur soon, the Fed would have about half the cutting ability it would need.

The New York Fed this week issued a report on quantitative easing that concluded the policy “can affect real economic outcomes” much like interest rate cuts because they spur “additional bank lending, which in turn translates into additional economic activity.”

Late last year, the Federal Reserve Bank of San Francisco suggested, “These tools likely strengthened the economic recovery and helped return inflation to the Fed’s target — although their full impact remains uncertain.”

Of course, one of the drawbacks of the Fed’s large-scale asset purchases is it “flooded the system with reserves," former Philadelphia Fed President Charles Plosser said at a Shadow Open Market Committee meeting earlier this year. And, as a result, the Fed is still dealing with a bloated balance sheet.

Brainard also said another feature of the “new economy” is a strong labor market that hasn’t led to inflation, and inflation that “doesn't fall as much in recessions,” which “makes it more difficult to boost inflation to our objective of 2% on a sustainable basis.” She said economists refer to this as a flat Phillips curve.

The accuracy of Phillips curve inflation forecasts could be improved by adding an inflation-output gap interaction variable, Kevin J. Lansing, a research advisor in the Economic Research Department of the San Francisco Fed, wrote in an Economic Letter.

Brainard said what she “would like to hear more about involves targeting the yield on specific securities, so that once the short-term interest rates we traditionally target have hit zero, we might turn to targeting slightly longer-term interest rates — initially one-year interest rates, for example — and if more stimulus is needed, perhaps moving out the curve to two-year rates.”

Separately, a working paper by Jim Dolmas, senior economist, at the Federal Reserve Bank of Dallas, and Evan F. Koenig, senior vice president at the Bank, finds “Trimmed-mean [personal consumption expenditure] inflation is more strongly and reliably related to labor-market slack than are either headline PCE inflation or ex-food-and-energy PCE inflation, and is more predictable than either of these alternative inflation measures.”

Andrew Dassori, CIO of Wavelength Capital Management, said in a recent Bond Buyer podcast, "an update to a pretty longstanding mandate could make a lot of sense." He added, "Bringing in new ideas ... is key to allowing the Fed to move forward."

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Monetary policy Lael Brainard Federal Reserve FOMC Federal Reserve Bank of San Francisco Federal Reserve Bank of Philadelphia