Fed doves strike back

October 4, 2013


Now that Washington’s circus-like government shutdown has put a damper on hopes for stronger U.S. economic growth going into next year, dovish Federal Reserve officials again appear to have the upper hand in the way of policy commentary.

Take Eric Rosengren, the Boston Fed President who had been unusually quiet as the tapering debate gathered steam. In a speech in Vermont on Thursday, he returned to a familiar theme – the central bank still has plenty of firepower and should not be afraid to use it.

Unfortunately, most of the risks to the outlook remain on the downside. Concerns over untimely fiscal austerity here and abroad, and the possibility of problems once again emerging in parts of Europe, could cause the Federal Reserve to miss on both elements of its dual mandate – employment and inflation – through 2016.

In my view, the asset-purchase program should remain dependent on incoming economic data, and we should seek to get the economy on a path to achieve both elements of the Fed’s dual mandate – employment and inflation – as soon as possible, hopefully by 2016. Should the economy speed up more rapidly than is sustainable, we can remove accommodation more quickly.

Should the economy unexpectedly slowdown, we can and should provide more accommodation than is currently anticipated. If the economy evolves as expected, policy should in my view include only a very slow removal of accommodation over the next several years – and that should only occur when the data ratify our forecast for an improvement in real GDP and employment.

Of particular concern to Rosengren is the continuous and poorly understood decline in the size of the labor force.

Unfortunately, what sounds like a temporary decline in the labor force participation rate could turn into a permanent one. A significant concern is that the longer we have such an elevated unemployment rate, the more likely it is that some of those who have left the labor force due to the lack of jobs will simply never return. In this way the decline in labor force participation could become permanent, implying an ongoing loss of employment and income for those workers – a very serious matter for our fellow citizens and for our economy.

San Francisco Fed President John Williams remained a bit skeptical of taking bond buys too far:

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.  Indeed, the recent outsize movements in bond rates in response to Fed communications about our current asset purchase program illustrate the difficulty in gauging the effects of asset purchases.  Moreover, given our limited experience, we can’t be sure of all their consequences, which may play out over many years.

Still, even Williams appeared to lean in a more aggressively pro-stimulus direction.

Before the financial crisis and recession, unconventional monetary policies were still mostly theoretical concepts on the drawing board, untested on the battlefield.  In practice, they have given central banks such as the Federal Reserve much-needed tools when the traditional policy interest rate is near zero.  We have learned a great deal over the past few years about their effectiveness, but also about some of their limitations.  As I have discussed, in normal times, certain types of unconventional policies are best mothballed and kept in reserve in case needed.  But, more importantly, the experience with these policies means that if another situation arises where we need to call on these tools, we are ready and prepared to do so.

Dennis Lockhart, the Atlanta Fed’s policy centrist who was open to tapering in September, said he believes the Fed made the right call in holding off.

I do think that the decision to in all likelihood delay a decision to taper that we took at the last meeting now is vindicated by the developments, specifically the development of the shutdown of the federal government and the potential impact that might have on the economy. So I think we avoided a potentially very awkward situation of reducing stimulus just on the eve of what now has developed, that strikes me as quite a wise decision.

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