Clarida: Lowering Inflation Created New Challenges for Central Banks
November 12 2019 - 5:59AM
Dow Jones News
By Nick Timiraos
The success of the Federal Reserve and other central banks in
reducing inflation and holding it at low levels has limited the
scope for monetary policy to combat future downturns, a top Fed
official said in a speech set for delivery Tuesday.
Fed Vice Chairman Richard Clarida highlighted how both lower
global bond yields and the successful response of the U.S. central
bank to combat the high inflation spells of the 1970s and early
1980s have laid the groundwork for new challenges.
"These two phenomena, taken together, have resulted in sovereign
bond yields that are substantially lower than the precrisis
experience, and thus substantially closer to the effective lower
bound for the policy rate than they were before the crisis," said
Mr. Clarida in remarks prepared for a policy conference in
Zurich.
Mr. Clarida's speech draws attention to a range of factors that
have pulled down long-term global bond yields, including the
decline not only in inflation but in the volatility of
inflation.
The Fed has typically cut its benchmark interest rate by more
than 5 percentage points in recent downturns. But with officials
unlikely to cut rates below zero, they will have less room to
reduce rates to stimulate growth with their conventional tools in a
future downturn.
The Fed added to its tool kit after the 2008 financial crisis,
but Mr. Clarida's speech highlights potential limitations of these
tools going forward.
After cutting rates to near zero in 2008 during the financial
crisis, the Fed conducted rounds of bond purchases over five years
to further stimulate growth. The central bank lowered long-term
rates and encouraged investors to purchase riskier assets, such as
corporate bonds, stocks and real estate.
Today, rates remain lower than before the crisis, limiting how
much the Fed and other central banks can stimulate growth by
pushing down long-term yields.
Following the last two recessions, for example, yields on the
benchmark 10-year U.S. Treasury yield declined by roughly 3.6
percentage points and 3.9 percentage points, respectively. "I will
confess that I think it highly unlikely in the next downturn,
whenever it is, that 10-year U.S. Treasury yields will fall by the
roughly" similar magnitudes, Mr. Clarida said.
The reality of lower global interest rates and bond yields has
been a motivating factor behind the Fed's review of its policy
framework, said Mr. Clarida. While many households may not see low
inflation as an undesirable outcome, it is a concern for the Fed
because a down-drift in inflation will also reduce nominal interest
rates, leaving less room to stimulate growth during and after a
downturn.
When central banks were first setting inflation targets in the
1990s, they were worried about inflation running too high and
sought to establish expectations -- for both business and consumers
-- that future inflation would be tame. Behind this approach was
the belief that expectations play an important role driving actual
inflation.
The Fed formally adopted a 2% inflation target in 2012. Under
the framework, it doesn't take into account what happened the year
before -- a "let- bygones-be-bygones" approach. Inflation has only
reached the target during a few months in 2018. It has held below
the target most of the time, raising concerns that inflation
expectations might drift lower.
As part of policy makers' review, Fed officials in September
examined approaches to allow for a "makeup" of past inflation
misses -- ending the "bygones" policy -- to help firm up inflation
expectations.
Mr. Clarida said the benefit of such an approach depended
critically, however, on the private sector's understanding the new
policy as well as the expectation that different Fed officials
would follow through on those promises.
"An advantage of our current framework over makeup approaches is
that it has provided the committee with the flexibility to assess a
broad range of factors and information," Mr. Clarida added.
The Fed is set to conclude its policy review and announce any
changes in the middle of next year, Chairman Jerome Powell said at
a press conference last month.
Write to Nick Timiraos at nick.timiraos@wsj.com
(END) Dow Jones Newswires
November 12, 2019 05:44 ET (10:44 GMT)
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