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Fed’s Evans Says Guidance on Tightening May Curb Inflation

Federal Reserve Bank of Chicago President Charles Evans said the central bank may be able to limit inflation as economic growth picks up by clarifying the changes that will prompt it to raise the main interest rate.

“The huge amount of accommodation required to maintain the funds rate path near zero clearly generates extremely vigorous macroeconomic activity putting at jeopardy the Federal Reserve’s price stability mandate,” Evans and three Chicago Fed economists wrote in a paper released today. “Conditioning, if credible, could be helpful in limiting the inflationary consequences of a surge in aggregate demand arising from an early end to the post-crisis deleveraging.”

Even after lowering the benchmark rate to zero, the policy-setting Federal Open Market Committee has continued to add stimulus by pledging to keep the rate low at least through late 2014. Evans has called for a more explicit promise, saying the Fed shouldn’t begin to tighten policy until the unemployment rate falls below 7 percent or inflation breaches 3 percent.

“Forward guidance in monetary policy statements has had a significant affect on yields of Treasury notes and corporate bonds since the onset of the financial crisis,” Evans and economists Jeffrey Campbell, Jonas Fisher and Alejandro Justiniano wrote in a paper prepared for a panel at the Brookings Institution in Washington.

The FOMC has changed the language on its rates pledge several times since cutting the main interest rate to close to zero in December 2008. At that time the committee said economic conditions would probably warrant low rates for “some time,” and changed that language in 2009 to “an extended period.” In August 2011, it specified a date of mid-2013, and in January extended that time to at least through late 2014.

Not Voting Member

Evans, who isn’t a voting member of the FOMC this year, has been among the most vocal proponents for additional Fed easing.

Policy makers must not “buy too quickly” into the notion that inflation expectations may soon surge or “we’ll end up following overly restrictive policies that could unnecessarily risk condemning the U.S. economy to a lost decade,” he said in Frankfurt last week.

Today’s paper tested how inflation would evolve either with or without Evans’ proposed thresholds, given two possible scenarios in which the economy performs above forecasts. If consumers finish deleveraging faster than expected, inflation would rise above 3 percent without an explicitly communicated threshold in place, the authors’ models showed.

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