Fed: Policy framework debate seeing more concrete contributions – ABN AMRO

Bill Diviney, senior economist at ABN AMRO, suggests that some Fed officials are already setting out their views on how best to improve the central bank’s strategies and tools.

Key Quotes

“The most important recent contributions have come from NY Fed President John Williams, who has co-authored an academic paper that makes the case for an average inflation target, while today, board member Lael Brainard gave a speech signalling scepticism over whether the Fed should make such a shift, instead arguing for the Fed to beef up its toolkit by considering, for instance, a yield curve target.”

“However, some Fed officials have expressed scepticism, with Cleveland Fed President Mester, for instance, asking ‘do the assumptions of the model really play out in real life?’, while St Louis Fed President Bullard warned that making radical changes to the framework could ‘unleash chaos’ in financial markets.”

“Brainard, meanwhile, referred to scepticism that central banks would be able to support above-target inflation sustainably, without ‘becoming concerned that inflation might accelerate and inflation expectations might rise too high’. With that said, Fed officials overall are expressing an open mind going into the June conference, and could yet be persuaded that the benefits of changing the framework would outweigh any costs.”

“At the same time, less controversial proposals to bolster the Fed’s toolkit are much more likely to find support. Brainard’s yield curve target proposal would involve the Fed targeting slightly longer term interest rates – one or two-year bond yields – using the balance sheet. However, instead of quantitative bond purchase targets, the goal would be purely to control rates (the Bank of Japan already has a similar policy, but targeting 10y yields). Such a policy could give greater credibility to a central bank’s forward rate guidance, although we note that it might also tie the central bank’s hands should it wish to expand the balance sheet quantitatively.”

“We are likely to see further proposals from Fed officials over the coming weeks and months, and following the conference in June, the FOMC will conduct a full assessment, sharing its conclusions in the first half of 2020. Should the Fed adopt an average inflation target – currently the most likely of the proposed framework changes – we believe it would raise the risk of easier policy next year, although our base case remains that the Fed keeps rates on hold.”

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