America’s key economic policymakers seem to be readying themselves for the possibility that the problems in Europe, plus a weakening level of demand in the domestic economy, might push growth back towards zero in coming months.
It’s only preliminary and the discussion is muted, but an interesting story carrying these arguments appeared in the Wall Street Journal yesterday.
This week’s release of the latest figures for industrial production, consumer and producer price inflation are part of the musing, given that production is expected to be strong, but inflation weak to non-existent, with perhaps signs of deflation starting to appear.
At the same time (and unconnected, it seems) a research paper from the San Francisco Fed has pointed out that the Fed could keep the current 0%-0.25% rate for the Federal Funds Rate steady until well into 2012.
The most adventurous private forecast pits the rate steady until early 2011, but this research paper says that given high unemployment and low inflation, the US Federal Reserve is likely to wait until 2012 before it starts to raise interest rates.
"Many predict that the economy will take years to return to full employment and that inflation will remain very low. If so, it seems likely that the Fed’s exit from the current accommodative stance of monetary policy will take a significant period of time,” the paper says.
The paper isn’t official Fed policy, but the author is a man called Glenn D. Rudebusch who is a senior vice president and associate director of research at the San Francisco Fed.
The SF Fed president, Janet Yellen, is President Obama’s nominee to be vice chair of the central bank from later in the year. For that reason, it has attracted a lot of interest in the past day.
“To deliver future monetary stimulus consistent with the past— and ignoring the zero lower bound — the funds rate would be negative until late 2012,” Mr. Rudebusch wrote.
“In practice, this suggests little need to raise the funds rate target above its zero lower bound anytime soon.” (Zero lower bound means that interest rates can’t go negative because that would mean lenders would hold cash and not lend.)
The paper points out that the Fed’s current forward-looking policy guidance is that “economic conditions – including low rates of resource utilization, subdued inflation trends, and stable inflation expectations – are likely to warrant exceptionally low levels of the federal funds rate for an extended period”.
"This guidance indicates that the length of the “extended period” depends on the expected path of unemployment and inflation.
"Similarly, the benchmark policy rule would prescribe an earlier or later increase in the funds rate if unemployment or inflation rose or fell more rapidly than predicted," the paper said.
Now there’s a two-day Fed meeting next week and the Wall Street Journal reported overnight that officials are now debating "quietly what steps they might take if the recovery surprisingly falters or if the inflation rate falls much more".
"Fed officials, who meet next week to survey the state of the economy, believe a durable recovery is on track and their next move—though a ways off—will be to tighten credit, not ease it further.
"Fed Chairman Ben Bernanke has played down the risk of a double-dip recession and signaled guarded confidence in the recovery.
"But fiscal woes in Europe, stock-market declines at home and stubbornly high U.S. unemployment have alerted some officials to risks that the economy could lose momentum and that inflation, already running below the Fed’s informal target of 1.5% to 2%, could fall further, raising a risk of price deflation.
"The Fed’s official posture is unlikely to change when policymakers meet June 22 and 23: The U.S. central bank is expected to leave short-term interest rates near zero and signal no inclination to change that for a long time.
"But behind-the-scenes discussions at the meeting could include precautionary talk about what happens if the economy doesn’t perform as well as expected."
"If the recovery falters or if inflation slows much further and a threat arises of deflation, a debilitating fall in prices across the economy. In such cases, there would be a few avenues the Fed could take."
