By Howard Schneider and Ann Saphir
MINNEAPOLIS/SAN FRANCISCO (Reuters) – Federal Reserve Chair Jerome Powell’s top deputies are edging towards an open dispute over basic elements of monetary policy in a clash that could shape the pace of interest-rate hikes in coming months as well as longer-term questions of how policy is conducted.
Fault lines are emerging across immediate issues like the estimate of the current neutral rate of interest, an abstract but critical variable that serves as a sort of speed limit on the current pace of interest-rate hikes. There are also long-term issues such as how the Fed should prepare for and combat the next economic downturn.
All involve technical questions that Fed policymakers may battle with competing economic models and philosophies, leaving it to Powell, a non-economist, to mediate.
San Francisco Fed President John Williams launched a critical salvo in the debate on Tuesday with a speech underscoring his view that the Fed has only a few more rates hikes ahead of it before rates reach neutral.
“It’s important to distinguish between the current strong economic conditions and the key longer-run drivers underpinning interest rates,” he said at the Economic Club of Minnesota. Despite tailwinds like tax cuts and government spending, “the longer-run drivers still point to a ‘new normal’ of a low (neutral rate) and relatively low interest rates.”
The view contrasts with recent optimism from some economists and central bankers. Among them is the Fed vice chair for financial supervision Randal Quarles who in February said he believes there is a “real possibility” that the economy could shift to a higher growth trajectory.
Williams, whose research has helped convinced most of his colleagues that the neutral rate of interest is much lower than in the past, stands to become even more influential when he takes over as chief of the New York Fed next month, a position that will put him in much closer contact with Powell and give him a stronger hand in shaping policy.
At his confirmation hearing, also Tuesday, Fed Board nominee Richard Clarida flagged what could be another, and related, point of disagreement at the Fed: whether the central bank should resort to bond-buying to fight downturns.
Clarida, an economist who advises fund manager Pimco, sounded skeptical.
Though the Fed’s initial program of so-called quantitative easing “made sense,” Clarida said he was not sure how he would have voted on subsequent rounds. “I do believe that the benefits of QE diminished as more and more rounds were added, and that the cost of QE went up.”
The Fed’s bond-buying programs, controversial particularly among Republican members of Congress, began in the depths of the crisis to stabilize banks and the financial system. They were expanded during the recovery to help bring down high unemployment and lift excessively low inflation.
Williams for his part on Tuesday called bond-buying an important part of its policy easing and said the Fed “is going to have to turn to quantitative easing” to fight future downturns. Rate cuts alone, from what will be a relatively low starting point and only able to fall as far as zero, would not provide enough firepower to stimulate the economy, he has said in the past.
Williams has also been pushing for a rethink of the Fed’s 2-percent inflation target. A new policy framework, he has said, conceivably could give the central bank a bit more breathing room by allowing it to leave interest rates lower for longer even if inflation pushes up to, or even past, its long-run target.
Clarida did not weigh in on that debate on Tuesday, or on his view of the neutral rate. But if he and fellow nominee Michelle Bowman are confirmed it is a topic that will heat up in coming months.
Source: Investing.com
