James Bullard has always been one of my favorite Fed Presidents, and that’s even more true after his recent comments on monetary policy:
The U.S. economy may only need one rate hike for as long as 2-1/2 years and the Federal Reserve is eroding its credibility by indicating otherwise, St. Louis Fed President James Bullard said on Friday in arguing for an overhaul of how the central bank views and discusses policy.
Bullard called for the Fed to discard its practice of projecting long-run values for things like economic growth and the target policy rate, acknowledge it has little certainty about the future, and state that the economy is not likely to get much worse or much better than it is now, absent some outside shock.
Bullard said he felt the appropriate federal funds rate is around 0.63 percent, roughly a quarter point above where it stands, and will likely stay there “for the foreseeable future.” For the Fed to publish projections that it will rise steadily to historic norms of three or four percent has been misleading.
The Fed’s “dot plot” of projected interest rate policy “appears to be too steep. Fed funds futures markets do not seem to believe it. They are priced for a much shallower pace of increases,” Bullard said.
“The Fed’s actual pace of rate increases has been much slower than what was mapped out by the committee in the past. This mismatch between what we are saying and what we are doing is arguably causing distortions in global financial markets, causing unnecessary confusion over future Fed policy, and eroding credibility of the (Federal Open Market Committee),” he said.
While that would seem to make the former inflation hawk now the Fed’s most dovish member, those labels would not apply as easily under Bullard’s way of thinking. Rather than see the economy on a continuum, with the interest rate used to moderate a tradeoff between unemployment and inflation, he said the Fed should instead view the economy as in a “regime.” The appropriate policy rate for that state would remain in place until a recession, productivity surge or other shock causes it to change.
This is a point I keep emphasizing. The issue is not what the Fed does or doesn’t do at the next meeting, it’s what sort of regime do they have. You can have monetary failures within a regime, but the overwhelmingly more likely problem is monetary failures caused by having the wrong regime (as when the Fed engaged in growth rate rather than level targeting in 2008-09.)
Monetary policy usually encompasses estimates of long-run equilibrium growth, unemployment and interest rates that the economy is expected to hover around, as a guide to how the economy might change over time. Bullard says the current situation may be much more static, an equilibrium that monetary policy has no reason to try to shift.
“On balance, real output growth, the unemployment rate, and inflation may be at or near mean values that could be sustained over the forecast horizon provided there are no major shocks to the economy,” Bullard wrote.
“Key macroeconomic variables including real output growth, the unemployment rate, and inflation appear to be at or near values that are likely to persist over the forecast horizon. Any further cyclical adjustment going forward is likely to be relatively minor.”
What sort of “major shocks” could produce a recession? I see two possibilities:
Demand-side: Britain votes to leave the EU. This triggers anti-euro sentiment in southern Europe. Fear of default leads to a crisis in PIGS debt, triggering a global decline in AD. Investors lose confidence in central banks. On balance, I don’t think this will happen, but it’s possible.
Supply-side: Regulatory changes and/or dramatically higher minimum wage rates push up labor costs in the US. I see this as somewhat more likely, but also as having a less powerful short run impact on employment and output, as compared to a demand shock.
Either shock could lead to a mild recession—in combination you could have a repeat of 1937-38. But on balance I still don’t expect a recession within the next year. In my view, recessions are mostly unforecastable, especially the part caused by demand-side changes.
Overall, Bullard’s statement is very good news. I encourage readers not to dwell on exactly where Bullard thinks the fed funds target should be set in the near future, and instead focus on his much more important views on how we need to think in terms of monetary policy regimes. With apologies to Bullard, I read him as saying something to the effect:
“Look, monetary policy is not about interest rates, it’s about hitting the dual mandate. There is no evidence that we need to dramatically adjust interest rates going forward to hit the dual mandate, so don’t pretend there is. The Fed should not be trying to ‘normalize’ interest rates, it should be trying to maintain high employment and 2% PCE inflation.”
PS. Bullard is somewhat more hawkish than Narayana Kocherlakota, but I see some similarities in the way they approach monetary policy. In both cases, it’s all about what does the Fed need to do to hit its targets—no other hidden agenda. I’ve argued that under a sound monetary regime the terms ‘hawk’ and ‘dove’ would no longer have any meaning, and hence I’d like to direct your attention to something in the quotation above:
While that would seem to make the former inflation hawk now the Fed’s most dovish member, those labels would not apply as easily under Bullard’s way of thinking.
HT: Brent Buckner