Fed Faces Skepticism Over Proposals to Improve Monetary Strategy

(Bloomberg) -- A posse of Federal Reserve policy makers met with skepticism last week when they described ways to potentially improve their management of the economy.

Participants at a Hoover Institution monetary conference questioned whether the central bankers have the will or the way to implement the fresh strategies they outlined, including average inflation targeting. The experts also voiced concern that the U.S. may be left vulnerable to a potentially deep and prolonged economic downturn.

“It seems very fragile,'' former Fed adviser Andrew Levin said Friday of proposals made during a panel discussion by Fed regional bank presidents from Cleveland, Dallas, St. Louis and San Francisco. “I lose sleep worrying'' that the economy is dependent on such shaky strategies, the Dartmouth College professor added.

The conference took place against the backdrop of an in-depth framework review by the Fed of its policies and practices that officials say will wrap up in the first half of 2020.

At the top of the agenda: how to conduct monetary policy at a time of low interest rates and low inflation. That's a world where the central bank has limited firepower to fight a recession, and where the risk of a deflationary decline in the economy is heightened as a result.

While Fed Chairman Jerome Powell has ruled out increasing the central bank's 2 percent inflation objective as part of the review, he's raised the possibility that it could adopt a “make-up'' strategy -- letting price increases run above target during good times like now, to offset the periods of slower price rises.

Perhaps the simplest version of that would be an average inflation target, with a mean of 2 percent over the entire economic cycle. New York Fed President John Williams and San Francisco Fed chief Mary Daly featured that approach in their presentations to the conference. The pair worked together when he ran the San Francisco bank prior to moving to New York.

The review may not necessarily end up delivering any changes. Daly said repeatedly that the bar was high to implementing an overhaul given all the uncertainties involved.

For instance, some conference participants wondered whether policy makers would be able to deliver on promises to make up for shortfalls or overshoots in inflation.

“It would be a very hard thing to do,'' said John Cochrane, a senior fellow at Stanford University's Hoover Institution. A Fed chair would have to tell Congress he or she was pursuing an inflationary policy that might not be best for the economy at that time, simply to make good on a pledge made in the past to act that way.

Any future promise by the Fed to deliver inflation above 2 percent for a time also would have to be judged against the central bank's failure so far to even lift it convincingly to that level. In March, prices rose just 1.5 percent from the year-ago level, according to the Fed's favorite inflation gauge.

“A framework review conclusion that promised to behave differently and contingently in the future would be regarded as having relatively little credibility in financial markets,'' Krishna Guha, head of central bank strategy at Evercore ISI, told the conference.

Monetary policy makers have bemoaned the depressed level of inflation but don't seem to be in a rush to cut interest rates in response, in spite of pressure from President Donald Trump to do so. Last week, Trump suggested the Fed slash rates a full point, and throw in some quantitative easing for good measure.

St. Louis Fed President James Bullard, considered one of the more dovish policy makers, told Reuters on the sidelines of the conference that he was prepared to wait through the summer to see if inflation recovered.

Some investors are betting that the Fed will ease credit by the end of this year, in part to help pave the way for the adoption of an average inflation targeting framework in 2020. When Guha raised the possibility of something like that happening to Williams, the New York Fed president didn't directly respond.

Former Philadelphia Fed President Charles Plosser voiced concern that policy makers would end their review by pledging more than they can deliver when it comes to controlling inflation and managing the ups and downs of the economy.

“A big risk would be the Fed promising some degree of precision in their strategy and then get frustrated over and over again by not being able to deliver with the precision that the markets think they can,'' Plosser said.

It was a breakdown in financial markets, of course, that led to the worst economic contraction since the Great Depression a decade ago.

Bank for International Settlements economist Andrew Filardo said the Fed review seemed to be giving short shrift to that disaster and the role that monetary policy potentially played in the run-up to it.

“I don't think any of the strategies would prevent a future crisis from occurring,'' he said.

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net

To contact the editors responsible for this story: Alister Bull at abull7@bloomberg.net, Ros Krasny

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