Daily Management Review

Policymakers Plan for 'Brave New World' as Fed Nears Rate Hikes


Policymakers Plan for 'Brave New World' as Fed Nears Rate Hikes
Federal Reserve policymakers are already weighing new tools they may need to fight the next recession but are signaling they could raise U.S. interest rates soon.
Fed Chair Janet Yellen told a central banking conference in Jackson Hole, Wyoming that a solid U.S. labor market "has strengthened" the case for the first rate increase since last December. The increase could come as soon as next month if the economy does well, several of her colleagues said.
As the U.S. central bank tries to balance a desire to fuel growth against worries it could overheat the economy, further rate hikes are expected to be few and far between.
New policy tools such as raising the inflation target or even Fed purchases of non-government-backed assets like corporate debt need to be considered to be used by the Fed, its officials also said at three-day conference that ended Saturday.
While some ideas would need congressional approval, such ideas would test the limits of political feasibility. The unconventional policies the Fed undertook during the last crisis have already made the public skeptical and the view within the Fed is that it could take effort to win over the public.
In an era of slower economic growth and a potentially giant and long-lasting trove of assets held by the Fed, policymakers think new tools might be needed. While rates look to be heading up, and they are convinced the time to vet them is now.
"Central banking is in a brave new world," Atlanta Fed President Dennis Lockhart said in an interview on the sidelines of the conference.
Built up by bond-buying sprees to combat the 2007-09 recession, at the center of the Fed's discussions is its $4.5 trillion balance sheet. It has been criticized by many lawmakers.
Lockhart said some officials were closer to accepting that they needed to learn to live with them while policymakers have maintained the Fed should eventually reduce its bond holdings.
"I suspect there are colleagues who are contemplating at least maybe a statically large balance sheet is just going to be a fact of life and be central to the toolkit," he said.
Through a process that would take years and would not begin until interest rate increases are well underway, officials have said they will slowly let the balance sheet shrink. Only in a very long-lived economic expansion, any form of substantial progress could be made.
"I am sure everyone in the audience would be happy if this were the reality. I certainly would be," Simon Potter, the New York Fed's markets chief, said during the conference.
As the Fed snaps up assets to stimulate the economy, balance sheets would likely swell again in future recessions, Yellen, in her speech on Friday.
A menu of more exotic proposals was presented at the conference that was attended by central bankers from around the world and by all but two of the Fed's 17 policymakers. Abolishing cash in order to charge negative interest rates and a Fed takeover of short-term debt markets were included in the proposals.
However many of the proposals were seen as ivory tower musings which included one to abandon monetary policy altogether and focus on urging runaway deficit-spending.
Tools used to combat such as rate cuts, bond purchases and jawboning on rate expectations in the last crisis were deemed to be adequate by most policymakers, including Yellen.
Including buying a wider range of assets or raising the inflation target, she said that "future policymakers might choose to consider some additional tools that have been employed by other central banks." Rather than their rate of change, the possibility of targeting the average level of prices in the economy were also cited be her.

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