Beckner: Chicago Fed’s Evans: Monetary Policy Not as ‘Normal’ As It Looks

Written exclusively for InTouch Capital Markets

3rd October 2018

By Steven K. Beckner

New York Federal Reserve Bank President John Williams has talked about monetary policy returning to “normal,” but Chicago Fed President Charles Evans has a different take.

Evans, who will vote on the Fed’s policymaking Federal Open Market Committee next year, says “the U.S. economy is firing on all cylinders” and “expect(s) this good performance to continue over the next few years,” despite some downside trade risks, but he has some longer run concerns. Formerly focused on below-target inflation, he’s now “more comfortable with the inflation outlook today than I have been for the past several years.”

So Evans considers “gradual adjustments in interest rates” appropriate. Citing the FOMC’s reaffirmed federal funds rate projections (one more hike this year, three next year, one more in 2020, taking it to 3.4%), he expects policy to become “mildly restrictive” – a stance he thinks “would be quite normal and consistent with some moderation in growth and a gradual return of employment to its longer-run sustainable level.”

“The FOMC’s stated intention of gradual increases in the federal funds rate target sounds pretty much like the more conventional, mainstream monetary policy that characterized the Fed’s actions in the 20 years prior to the financial crisis,” he says. “Considering the potential headwind or tailwind risks that might emerge, a gradual path gives us the flexibility to make appropriate risk-management adjustments to policy should they be called for.”

But the problem, Evans argues, is that things have fundamentally changed since the crisis:  “the potential growth rate of the economy and the neutral interest rate are a good deal lower than they used to be.” With the longer run “neutral” funds rate now just 3%, the Fed is much more likely to reach the zero lower bound if it has to fight recession.

So, Evans urges, “with the economy close to both our goals of maximum employment and price stability, now is a good time to take a hard look at whether—and how— the Fed’s strategic monetary policy framework might be modified to better deal with these potential challenges.”

One thing being considered is some framework that would allow the Fed to overshoot its inflation target persistently. Evans’ own view is that “we should concentrate more explicitly and publicly on outcome-based policy settings aimed at delivering maximum employment and 2% inflation on average through the business cycle. Bolstering the credibility that the FOMC will deliver on its policy mandates makes those goals more readily achievable.”

Since the economy is “about as good as it gets,” Williams said on Friday “the Fed has naturally been moving toward more ‘normal’ monetary policy.” Expecting inflation “to edge up a bit above 2%” but not much more, he believes “further gradual increases in interest rates will best foster a sustained economic expansion and achievement of our dual mandate goals.”

With policy no longer being called “accommodative” and heading toward neutral, Williams says “At some point in the future, it will no longer be clear whether interest rates need to go up or down, and explicit forward guidance about the future path of policy will no longer be appropriate.“

He warned against paying “too much attention” to r* (the real component of the neutral funds rate). “As we have gotten closer to the range of estimates of neutral, what appeared to be a bright point of light is really a fuzzy blur, reflecting the inherent uncertainty in measuring r-star.” Besides, “r-star is just one factor affecting our decisions.”

Meanwhile, Boston Fed President Eric Rosengren, once a “dove,” says rates likely need to become “mildly restrictive in order to best fulfil our mandate – stable prices and maximum sustainable growth.” For now, he says, “U.S. monetary conditions remain mildly accommodative, with short-term market rates barely higher than the inflation rate…”