Federal Reserve policy makers are laying the groundwork for further action at this month’s meeting, warning that U.S. economic growth could stall, producing lasting stagnation in the job market.
Federal Reserve Bank of Chicago President Charles Evans said yesterday the Fed should consider adding “very significant amounts of policy accommodation” and attacked the notion it should abide by a 2 percent ceiling on inflation. San Francisco Fed chief John Williams cited “a number of steps” that could be taken to support growth, without offering specifics.
The Fed may decide at its Sept. 20-21 meeting to replace some of the short-term Treasury securities in its $1.65 trillion portfolio with long-term debt in a bid to lower rates on everything from mortgages to car loans, according to economists at Wells Fargo & Co., Barclays Capital Inc. and Goldman Sachs Group Inc. Some analysts dub the maneuver “Operation Twist” because it would bend long-term yields lower. Fed Chairman Ben S. Bernanke is due to speak in Minnesota on the economic outlook at 1:30 p.m. New York time.
“There is basically one vote that matters, and that is Ben Bernanke’s,” said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. “This is clearly an activist leadership, and they are going to continue to push buttons until they are satisfied.”
Investors increased bets on further Fed stimulus after a Sept. 2 Labor Department report showed that hiring unexpectedly stalled in August and the jobless rate stayed at 9.1 percent.
Yield Spread Narrows
Yields on U.S. 10-year notes touched 1.9066 percent Sept. 6, the lowest on record, and were at 2.015 percent at 10:15 a.m. in New York. The spread between U.S. 10-year and two-year notes has narrowed to 1.82 percentage points from 2.05 points since the Fed’s Aug. 9 meeting in anticipation of Fed purchases of longer-dated securities.
After last month’s gathering, the Federal Open Market Committee said it would keep the benchmark interest rate low at least through the middle of 2013, replacing its earlier pledge to hold borrowing costs down for “an extended period.” Evans yesterday called that decision “a step in the right direction.”
Half of the 12 Federal Reserve banks reported slowing or subdued growth in their regional survey of the economy released yesterday, and a majority reported fewer price pressures.
Recent data “were quite definitive in showing the U.S. economy was not close to achieving launch velocity or getting growth up well above potential growth rates so we could make progress on the employment front,” Evans told reporters.
Evans said a 2 percent ceiling on the Fed’s inflation objective is “extremely, and inappropriately, asymmetric” in the context of a jobless rate that has averaged 9.5 percent for the past two years. Financial conditions are tighter than they should be because “households, businesses, and markets place too much weight on the possibility that Fed policy will turn restrictive in the near to medium term,” he said.
Evans said that indicates the public believes the Fed puts more emphasis on its mandate from Congress to keep prices low and stable over its second mandate for full employment.
The Fed could provide more stimulus by making a “conditional” statement that it would hold the federal funds rate at low levels until unemployment falls to around 7 percent or 7.5 percent “as long as medium-term inflation stayed below 3 percent,” he said.
Economists such as former Fed Governor Laurence Meyer and Mark Gertler, a New York University professor and research co-author with Bernanke, are also advocating more communication by the Fed about its inflation and employment goals as a way of encouraging expectations that rates will stay low for longer.
Gertler said the committee could express a range of tolerance around its long-term goal for inflation, currently 1.7 percent to 2 percent. That would help alleviate concerns that the Fed might prematurely tighten policy as inflation accelerates toward that range.
The Fed’s preferred inflation gauge, the personal consumption expenditures price index, minus food and energy, was at 1.6 percent for the year ending July.
“The FOMC could say we have a target of 2 percent for core inflation with a range of tolerance between 1.5 percent and 2.5 percent, for example,” said Gertler.
The Fed could then signal that as long as unemployment remains above a certain level, temporary movements of core inflation above the range of tolerance would be permissible. Any moves closer to a “danger zone” of 3 percent would then compel action, Gertler said.
This approach would be closer to the flexible inflation targeting outlined by Bernanke in a 2003 speech when he was a Fed governor, which leaves room for discretion and patience for price gains to move back down toward the stable target over time.
Meyer, now at Macroeconomic Advisers LLC, a St. Louis forecasting firm he co-founded, said he also expects the committee to eventually adopt “bolder, more imaginative approaches to easing.”
Meyer, in a note to clients, said the committee could announce a “monitoring range” around a medium-term target for headline inflation of 2 percent. The short-term range would focus on core inflation, or prices excluding food and energy, of 1.5 percent to 2.5 percent at an annual rate.
“If the labor market does not improve significantly, the FOMC would keep the funds rate ‘exceptionally low’ as long as near-term core inflation is projected to stay within the monitoring range,” Meyer wrote. The core PCE index is not expected to move above 2.5 percent “for a very long time,” so the policy would signal the FOMC would not start removing policy accommodation until well beyond 2013, he said.
“We just think that they are going to have to be more imaginative at some point,” Meyer said in an interview. “We are in unprecedented circumstances.”