Future Fed Policy

Before I get to my main entry, you really should go to this link and read this article.  At the bottom of the article, you can read the draft of the comments that President Nixon was supposed to make if we were not able to bring Neil Armstrong and Buzz Aldrin back from the moon.  It really takes you back in time and makes you remember the risks we were taking and the bravery involved.

Now, on to my main entry…

Two Fed Presidents spoke on Monday: Charles Evans (Chicago) and Sandra Pianalto (Cleveland).  I may write more about them later this week, but here’s a quick summary of their comments about future Fed policy.  It’s particularly interesting as markets are awaiting Chairman Bernanke’s Friday morning speech in Jackson Hole.

President Evans:

1. The FOMC should make it clear that we will not raise the Fed funds rate until unemployment goes below 7%.  This will eliminate fear that we’re going to prematurely end our accommodation.

2. Evans doesn’t think that Fed policy will cause inflation.  But, if it does, we should start to raise rates if the outlook for inflation over the medium term rises above 3%.  (Remember, the Fed’s stated inflation target is 2%.)

3. We should purchase more mortgage-backed securities.  These should be open-ended – continuing until we see improvement in economic conditions.  An example of “improvement” would be two or three consecutive quarters of steady growth in unemployment.  At that point, he would stop the purchases, but would leave rates at zero (until unemployment was below 7% or inflation above 3%).

President Pianalto:

1. She spent significant time talking about the benefits and costs of Fed policy.  Interestingly, she discussed the fact that low rates can only do so much (limited benefits).   But, she said that policy has lowered rates and allowed people to refinance.  It has helped corporations raise cash and it has also fought off fears of deflation.

2. She discussed the fact that we have no real idea of the long-term results of these policies.  There is always risk of financial institutions “reaching for yield.”  It’s also possible that financial institutions may hold too many fixed-rate assets and they could be hurt when rates increase.  Finally, there’s always the possibility that the Fed involvement in the system could distort markets.  (You think?)

3. She concluded that risks are present, but she favors further accommodation.

Have a great week.

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