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Fed policymakers call for quick, strong action in next downturn

Reuters logo Reuters 2/21/2020 Howard Schneider

The U.S. central bank will need to act aggressively to counter future downturns, deploying old tools more quickly and adopting new ones, Federal Reserve Governor Lael Brainard said Friday.

Her remarks, to the annual University of Chicago Booth School of Business forum on monetary policy, came as traders in financial markets piled into bets that such action could be needed sooner than thought.

Intense efforts are underway at central banks globally to develop new ways to fight shocks amid low inflation and low interest rates that make conventional responses, like simply reducing a target borrowing rate, less potent than before.

Brainard's call Friday for expanding the Fed's policy arsenal came in response to a research paper presented at the conference providing new evidence that the bond-buying and forward guidance deployed during the last crisis had mixed results and could have been more effective had they been used more decisively.

"The lessons from the crisis would argue for an approach that commits to maintain policy at the lower bound until full employment and target inflation are achieved," Brainard said. "This forward guidance could be reinforced by interest rate caps on short-term Treasury securities over the same horizon."

In the last crisis, the Fed did vow to keep interest rates at zero until certain employment and inflation targets were met, but only did so after years of trying other tools.

And the Fed has never before used yield curve caps, which would deliver further policy easing than forward guidance or bond-buying alone, although other central banks have tried it.

Brainard's call for strong action in response to a future shock were made in response to a research paper released Friday at the conference that argued that the unconventional monetary policies deployed during the last crisis had mixed results and could have been more effective had they been used more decisively.

And she is not alone at the Fed, which plans by mid-year to update its strategies and framework to make monetary policy more effective given the difficulty it has had in boosting inflation to the 2% target despite unemployment near 50-year lows.

“I am convinced that we can act faster and with more commitment using tools we already have, such as forward guidance," Richmond Fed President Thomas Barkin said on Thursday. "In the last downturn we were pretty hesitant to move too aggressively. These were new tools. We feared an outbreak of inflation or financial instability. We have learned we can act faster and more forcefully."

Financial markets are signaling their worries that such a shock could come sooner than expected.

On Friday a report showed U.S. business activity stalled in February on worries over the new coronavirus that has triggered travel restrictions and factory shutdowns in China, choking global supply chains as a result.

Stocks fell, yields on U.S. Treasuries sank, and interest-rate futures traders are now in pricing in two U.S. interest rate cuts by year's end.

Most Fed policymakers have signaled they are not inclined to reduce rates this year after cutting them three times last year, though they have a weather eye on the impact of the new coronavirus epidemic.

To Brainard, communication is a key component of the Fed's expanded tool box, saying the Fed should clarify in advance that "we will deploy a broader set of tools proactively to provide accommodation when shocks are likely to push the policy rate to its lower bound.

Equally important, she added, "we should adopt a strategy that successfully achieves maximum employment and average inflation outcomes of 2 percent over time."

Brainard said she supports a strategy where the Fed would target a range of inflation outcomes that would allow it to achieve 2% on average overall, known as flexible average inflation targeting.

And she also called, as have other Fed officials, for stronger fiscal responses in a downturn, since monetary policy alone will likely not be enough.

Citibank chief economist Catherine Mann, one of the paper's authors, went further.

"Policy coordination across countries may be an important way in which to deal with a global financial stress," she told the conference. "Monetary policy cannot be the only game in town.” 

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