Short-term interest rates and "some aspects of forward guidance" will remain future monetary policy tools, Federal Reserve Bank of San Francisco President and CEO John C. Williams said Thursday.
"The short-term interest rate remains the best primary tool for future monetary policy," Williams told the University of California Economic Roundtable, adding he sees "a continuing role for some aspects of forward guidance."
While unconventional policies will remain important "for the next few years," he said "the new normal for future monetary policy" will return to setting short-term rates, with "greater transparency... about the likely future path of the federal funds rate."
"I expect that the explicit link between future policy actions and specific numerical thresholds, as in the recent FOMC statements, will not be a regular aspect of forward guidance, at least when the federal funds rate is not constrained by the zero lower bound," Williams said. While "a powerful tool" when the Fed funds rate target is near zero, it would not be appropriate when rates are higher.
"Such communication is difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity," he said. "Therefore, in normal times, a more nuanced approach to policy communication will likely be warranted. I see forward guidance typically being of a more qualitative nature, highlighting the key economic factors that affect future policy actions. Of course, if we again find ourselves in a situation where conventional policy has been fully utilized, then we will have the ability to return to more explicit forward policy guidance to provide additional monetary stimulus."
Asset purchases should be saved for times "when the federal funds rate is near zero and we have fully utilized forward policy guidance. Despite all that we've learned, the effects of asset purchases are much less well understood and are much more uncertain and harder to predict than for conventional monetary policy."
With limited experience with the unconventional tools, there could be unforeseen "consequences, which may play out over many years."
But, at the time they were employed, the Fed had few options. "When the federal funds rate was at zero and we were still facing a severe recession, it was the right call to turn to asset purchases," Williams said. "But, once the federal funds rate is back to a more normal level, we should relegate asset purchases to a backup role, employing it only when conventional policy and forward guidance fall short."
As for the economy currently, despite four years of improvement, "we are still falling short of our mandate for maximum employment. In addition, the rate of inflation has been running well below the Fed's preferred 2 percent goal for some time," he noted.
This makes very accommodative monetary policy appropriate "for quite some time."