Sept. 20 (Bloomberg) -- Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank should hold the main interest rate near zero until unemployment falls below 5.5 percent, marking the first time he has linked policy to a specific economic goal.
“As long as the FOMC is continuing to satisfy its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent,” Kocherlakota said today in a speech in Ironwood, Michigan, referring to the policy-setting Federal Open Market Committee.
The FOMC announced a new round of quantitative easing last week to spur growth and job creation, while forecasting that the benchmark interest rate will stay at a record low through at least mid-2015. As recently as May, the Minneapolis Fed chief said the central bank may need to begin an exit from record stimulus as early as year-end.
Kocherlakota embraced a proposal by Chicago Fed President Charles Evans to calibrate monetary policy based on specific economic goals. Evans advocates holding to near-zero rates until the jobless rate falls below 7 percent or inflation reaches 3 percent.
“My thinking has been greatly influenced by his,” Kocherlakota said, referring to Evans. “By increasing monetary accommodation, the Committee can better meet its employment mandate while still satisfying its price-stability mandate,” Kocherlakota said to business and community leaders at Gogebic Community College.
“It’s an appropriate time to start thinking about when to begin the process of reversing the level of accommodation,” Kocherlakota said on May 9. “Six to nine months down the road, we should be thinking about initiating our exit strategy.”
Today, Kocherlakota said that under his proposal the central bank may not raise rates for “four or more years.”
“The FOMC can provide more current stimulus if people believe that liftoff will be triggered by a lower unemployment rate,” he said.
Speaking to reporters after his speech, Kocherlakota said his policy view shifted in recent months because of a variety of factors, including a diminished inflation threat. During the past two to three months, he’s seen “more downward pressure” on prices, he said.
Also, recent research indicates “much of what’s going on with the unemployment rate is not structural,” suggesting that the Fed has more room to bolster growth without stoking inflation, he said.
Kocherlakota said he would have voted in favor of the FOMC’s decision to roll out a new round of stimulus last week, His policy proposal would help “enhance” the effects of the current easing measures in place, he said.
Stocks fell today as data from Japan to China to Europe increased concerns that the global economic outlook is worsening. The Standard & Poor’s 500 Index fell 0.1 percent to 1,459.45 as of 3:38 p.m. in New York
The FOMC should give itself leeway by allowing inflation to deviate from its 2 percent target, Kocherlakota said. The committee could contemplate raising rates if inflation rises above 2.25 percent, he said.
This medium-term price level makes policy more “responsive” to economic developments and adds a safeguard lacking in the current pledge to keep rates low, he said to reporters.
History suggests it’s unlikely inflation will rise above that point as long as the jobless rate remains above 5.5 percent, he said. Inflation will run at or below 2 percent for the next two years, while the unemployment rate may fall to 7.5 percent, he said. He added that he’s not seeking to fuel economic growth by allowing inflation to accelerate.
“I am doubtful about the efficacy of the inflation-based approach,” he said. “Many households would believe that their wage increases would not keep up with the higher anticipated inflation rates,” prompting them to save more and spend less, he said.
Confident the Fed will keep the fed funds rate near zero until achieving 5.5 percent unemployment, “people will spend more today, and that will drive up economic activity,” Kocherlakota said.
“The current economic impact of both forms of accommodation -- low interest rates and asset purchases -- depends on when the public believes that accommodation will be removed,” he said.
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