“The way they’ve set this review up makes it very hard to end up reaffirming the old status quo,” said Krishna Guha, who leads central bank strategy at Evercore ISI. “They’ve explained why the old regime no longer works as well as in the past, and having explained that problem you can’t then conclude that what they’re doing is fine.”
One priority, according to a recent speech previewing the effort by Mr. Clarida and interviews with Fed officials, will be how the Fed should react when it misses its inflation target, as has happened year after year.
Presently, the Fed’s approach is known internally as the “bygones” approach — let what happened in the past be in the past, and set policy based only on what you expect for the future. Using that logic, the central bank has kept setting interest rates aimed at attaining 2 percent inflation.
In practice, that has meant the Fed has been the equivalent of a driver who aims to go 60 miles an hour but starts tapping the brakes every time the car gets over 55.
If, instead, the Fed tried to target a steadily rising price level, or achieve average inflation over many years of 2 percent, it might avoid the problem. That would be the equivalent of a driver with an average speed of 55 being comfortable driving at 65 miles per hour until the average rises to the goal of 60.
In the current monetary policy environment, it would mean keeping rates lower for longer, allowing the economy to overheat until inflation was tracking comfortably above 2 percent for a time.
There are problems with that approach. President Trump’s drumbeating for lower rates notwithstanding, there would most likely be political backlash during the time inflation was overshooting the goal — it would be as if our driver got a speeding ticket while going 65. Already in congressional testimony this year, Mr. Powell has heard from senators who implored him not to allow inflation to rise.
Article source: https://www.nytimes.com/2019/04/29/upshot/how-fed-can-fight-next-recession.html?partner=rss&emc=rss