As investors discuss when would the Federal Reserve of the United States to raise interest rates in the short term, in the meeting of central bankers around the world in Wyoming this week is likely to emerge a debate on what they can do if a future crisis forces them to reverse monetary policy.
the policymakers will meet in the mountain resort of Jackson Hole, amid concerns that the artillery have to fight recession is small, and perhaps a revision to the way the authorities is necessary direct their way through the economic cycle.
last week, John Williams, president of the San Francisco Fed, presented reform ideas that challenge some of the basic assumptions of the tribe of central bankers. Among its recommendations was the idea of a target higher inflation to give a boost to the room for maneuver of central bankers when a recession comes.
Williams not urged changes give soon, but the reason its suggestion was clear. Eight years after the crisis, the waterfall unprecedented monetary stimulus still left many major economies with low growth rates and a small inflation. With rates at a minimum or near the floor, there is little or no room for further cuts to stimulate growth.
“This debate is really about the next recession and the size of space you have to counter it “says Donald Kohn, former vice president of the Board of the Federal Reserve who is now at Brookings. “We need a rethink on the extent that central banks have to mitigate”.
Policy makers are nervous because the evidence is that the so-called neutral rate-the interest rate that is consistent with the economy operating balance- stalled in a heavily depressed levels. Possible engines for this decline include a small growth in productivity, an aging population, and excess savings worldwide. The phenomenon is seen in a number of major economies, including the US, Canada, the euro zone and the UK.
With neutral low rates, central banks have a lower degree of influence on the economy . They can slow the activity by raising policy rates, but there is little room for stimulus through the cuts. Tim Duy, an economics professor at the University of Oregon, says: “It appears that central banks lack the capacity themselves to guide the activity how they need”
Central bankers insist. they have more tools at their disposal than some claim. Central banks in Europe and Japan experienced negative rates, as with asset purchases as they seek more ways to relax even more. The Bank of England received encouragement from brexit to launch an effort stimulus through rate cuts and new asset purchases.
A recent document of the Board Federal Reserve argued that the deployment of rate cuts, asset purchases and guidelines for the future, together, can be even more effective than a hypothetical scenario where the central bank cut rates to enter negative territory much as you want instead of limiting them to a zero level.
However, the attractiveness of seeking higher inflation is that it involves interest rates higher long term and, therefore, more weapons to reduce rates when comes a recession. Joseph Gagnon, a former Fed economist who now works at Peterson Institute for International Economics, says it’s an idea whose time has arrived.
“If you go into a recession with inflation at 4 percent and not 2 percent, then the whole structure of interest rates will be even higher, “he says.
However, raising the inflation target is not a change of policy that is” no brainer “argues Kohn. Move to an inflation target of 3 percent will require “a very serious conversation with Congress,” for example, about the definition of price stability in the legislation of the Fed.
In addition, part costs can be difficult to quantify. Former Fed chairmen Alan Greenspan and Paul Volcker used to define price stability as a rate where households and businesses do not have to pay attention to inflation. “Two percent may be on the edge, but 3 percent may be over,” he said.
If the inflation target, the central bank will have to demonstrate to the markets that can actually rises designing an acceleration in price growth for the new target. If it fails, then it will weaken its credibility.
Some economists argue that the tax authorities will have to work harder than central banks for future recessions. Duy, for example, is in favor of a higher inflation target or alternatively a target of nominal gross domestic product. But he also says that in the US the new “automatic stabilizers” are needed in budget plans to support the economy during a crisis.
The problem with these proposals lead to higher budget deficits in a recession is they are opposed by skeptical Republicans on Capitol Hill, just as proposals for central banks to seek higher inflation.
by the time the novel ideas to make way they discussed the bankers plants probably remain in the realm of the theoretical.
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