Evans Won New Fed Consensus Linking Rates to Unemployment
Among those at the March European Central Bank symposium in Frankfurt was Otmar Issing, the former top economist at the ECB and one of Europe’s fiercest inflation fighters. Some months before, the idea of tolerating rising prices had been branded “irresponsible” by Paul Volcker, who as Fed chairman in the 1980s induced a recession to protect the value of money.
“With Otmar in the audience, I was nervous,” Evans, president of the Chicago Fed, recalled later. Yet he pressed on, telling his audience, “monetary policy can and should take additional steps to facilitate a more robust economic expansion.”
Evans’s appearance in Frankfurt was one of 13 stops in a more than yearlong odyssey that took him from Detroit to Bangkok to push an untested policy tool: linking the outlook for interest rates to unemployment and inflation. The Fed finally heeded his call on Dec. 12, deciding to keep rates near zero as long as unemployment remains above 6.5 percent, inflation is no more than 2.5 percent and long-term inflation expectations are well anchored.
The decision was a testament to what former colleagues call Evans’s ability to build consensus. It also shows how one of the Fed’s 12 regional bank presidents can influence policy that is usually made by the central bank’s Washington-based board of governors, led by Bernanke.
“Through the power of his ideas and his powers of persuasion, President Evans was gradually able to gain some momentum behind this idea in the Fed,” said Carl Tannenbaum, chief economist at Northern Trust Corp. in Chicago, where he was an economist and supervisor for the central bank.
Evans’s campaign wasn’t the first time he has pushed against accepted economic ideas. Evans in his doctoral dissertation at Carnegie Mellon University argued that economists Edward Prescott and Finn Kydland had overstated the impact of technology in driving the business cycle, research that later won them the Nobel Prize in economics. Monetary policy also plays a part, Evans said.
“Even then, you could see that Charlie was struggling to get out of the mainstream view at Carnegie if not the world,” said Martin Eichenbaum, who was Evans’ thesis adviser and is now a professor at Northwestern University in Evanston, Illinois. “He was questioning conventional wisdom back then and that’s what he’s doing now.”
Evans declined a request for an interview, according to Chicago Fed spokeswoman Laura Labarbera. He described the ECB’s March event at a gathering later that month at the Brookings Institution in Washington.
The adoption of Evans’s proposal to link rates to unemployment was another foray into unprecedented measures for Bernanke’s Fed. Since 2008, Bernanke has cut the main interest rate to zero and bought more than $2.3 trillion in securities to fuel growth. Yet more than three years after the recession ended, unemployment remains at 7.7 percent, far above the Fed’s estimate of long-run unemployment at no more than 6 percent.
Dissatisfied with the results, Bernanke this month embraced Evans’s plan and said the Fed will also buy $45 billion in Treasuries in addition to the $40 billion of mortgage backed securities it was already purchasing each month.
The Fed chairman, who as a scholar of the Great Depression focused on the costs from central bank inaction, has shown he is willing to seize on any tool that may bring down joblessness, said Jason Schenker, president of Prestige Economics LLC in Austin, Texas.
“The Fed is really throwing the kitchen sink at this,” he said. “And the crazy thing is they could still do more.”
Bernanke’s accommodation has helped stoke a 13.7 percent gain this year in the Standard & Poor’s 500 Index, which has weathered a slowdown in the global economy, Europe’s sovereign debt crisis and lackluster U.S. job growth. Fed stimulus has also spurred demand for government bonds, with the yield on 10- year Treasuries declining 11 basis points in 2012.
The stock index closed at 1,430.15 on Dec. 21 and the yield on the benchmark Treasury note closed at 1.76 percent.
Evans started advocating his approach a month after one of the most controversial FOMC decisions under Bernanke’s chairmanship. In August 2011, as the recovery showed signs of faltering, the committee said it would hold the main interest rate near zero through at least mid-2013, tying policy to a calendar date for the first time.
The disagreements highlighted the FOMC’s aversion to fixing monetary policy to a date, and the challenge the chairman would face in achieving consensus on altering the date as the economy evolved. Since Bernanke favored using forward guidance as a way to keep interest rates low and spur the recovery, policy makers needed to find a new benchmark.
While Evans supported the August 2011 decision, he wanted to go further. The next month he made his first public call for Fed officials to step up accommodation by pledging to keep rates at zero until reaching a certain level of unemployment.
Research by economists such as Michael Woodford, now at Columbia University in New York, had shown that when the short- term interest rate is already near zero, a central bank can ease policy further by committing to keep stimulus in place.
The unemployment rate, at 9 percent at that time, should “have our hair on fire,” Evans said in London in September 2011. “The clock is ticking -- the longer we wait, the more likely it is that unutilized skills diminish to the point that more permanent damage takes hold.”
Volcker was quick to respond. After becoming Fed chairman in 1979, he had pushed the federal funds rate to as high as 20 percent to throttle inflation in 1980.
“Remarkably, at least one member of the Fed’s policy making committee recently departed from the price-stability script,” he wrote in the New York Times two weeks after Evans’ speech. Once central bankers allow for higher inflation, “the instinct will be to do a little more -- a seemingly temporary and ‘reasonable’ 4 percent becomes 5, and then 6.” Volcker declined to be interviewed for this story.
Evans’s plan also received a cool reception among current policy makers. Vice Chairman Janet Yellen in an October 2011 speech said it was “potentially promising” while “not without pitfalls.”
At the November 2011 FOMC meeting, Evans’s approach won some support. It also drew fire from several participants who said it may be “confusing,” according to minutes of the gathering.
The Chicago official was undeterred and cast his first dissent, asserting the economy needed a stronger jolt from a clearer policy pledge. He dissented again the following month.
Now 54, Evans has spent more than a third of his life inside the Fed system. Born in Greenville, South Carolina, Evans studied economics at the University of Virginia in Charlottesville and received his doctorate in 1989 at Pittsburgh-based Carnegie Mellon.
In 1991, after briefly teaching at the University of South Carolina, the young economist was recruited to the Chicago Fed’s research department by Eichenbaum, his former professor and a consultant to the district bank.
Evans, a natural consensus-builder capable of explaining complex ideas to non-economists, was the “perfect fit” for the job, Eichenbaum said. He rose through the ranks, becoming director of research in 2003 and president in 2007.
A little more than four years since he took the helm, Evans partook in a historic FOMC meeting that opened up U.S. central banking to public view. On Jan. 25, the Fed adopted a 2 percent inflation target and released each official’s projections for the benchmark interest rate.
The committee also pushed the date back to late 2014 for keeping rates near zero because the economy was weakening. A discussion over adopting thresholds failed to move the proposal forward.
Evans didn’t stop. In March, he flew to the ECB conference in Frankfurt. His speech followed a panel discussion featuring Issing.
The following week he traveled to the Brookings Institution and presented a 47-page paper that he co-authored laying out the math underlying his plan.
Meanwhile, data ranging from job growth to manufacturing flashed signals the economy was faltering. While Evans still had no public backers, some of his colleagues were beginning to favor more easing in the form of expanded purchases of bonds, or quantitative easing.
Evans was among the central bankers who gathered in August at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming. Columbia’s Woodford said the Fed may be sending a negative signal about the economic outlook each time it said it expects to keep rates at zero for longer. Evans’s proposal offered “an important improvement” over such date-based guidance, Woodford said.
At the Sept. 12-13 meeting the FOMC again pushed back its forecast for an interest-rate increase, this time to mid-2015. The committee also said it expects to keep rates low “for a considerable time after the economic recovery strengthens,” taking the first step toward linking policy to economic conditions.
“Many participants” said numerical thresholds tied to economic data would offer better guidance to the markets, according to minutes of the gathering.
Seven days later, Evans won an ally in the Minneapolis Fed’s Kocherlakota, who became the first Fed official to publicly endorse the Chicago chief’s proposal. It was a year and 13 days after Evans made his first call for thresholds in London.
Kocherlakota advocated keeping rates at zero until unemployment falls below 5.5 percent as long as inflation remained below 2.25 percent. It was a complete turnabout: In May he said rate increases may be needed by the end of 2012.
“My thinking has been greatly influenced by his,” Kocherlakota said of Evans’s proposal.
The debate on policy thresholds burst into public view. Plosser and Fisher warned that the Fed can’t target unemployment. James Bullard of St. Louis said it would be a “mistake” to base policy on “a fickle variable” like the jobless rate.
In November, Boston’s Eric Rosengren said he favored an unemployment benchmark of 6.5 percent, and Yellen said she was “strongly supportive” of the concept of a thresholds-linked pledge. Atlanta Fed President Dennis Lockhart signaled he may support the approach as well.
Evans shifted his benchmarks closer to Kocherlakota’s, proposing levels of 6.5 percent joblessness and 2.5 percent inflation.
Still, there were few signs the policy makers would back a policy threshold at its last meeting of the year. FOMC participants believe that before taking such a step, the Fed “would need to resolve a number of practical issues,” according to minutes of the committee’s October meeting.
Only one of the 49 economists in a Dec. 7-10 Bloomberg survey predicted policy makers would set such guidelines in the gathering. The FOMC would probably wait until its March 19-20 meeting before taking such a step, according to the median estimate of surveyed economists.
On Dec. 12, the committee endorsed the benchmarks with Evans’s new numbers, saying the commitment hinges on whether “longer-term inflation expectations continue to be well anchored.” The FOMC vote was 11-1 for an innovation the Fed had never attempted before, with Richmond’s Jeffrey Lacker dissenting.
More than three years of recovery hadn’t erased the “enormous waste of human and economic potential” from high unemployment, Bernanke said in a press conference after the FOMC released its statement.
Policy makers at the December meeting deemed that using Evans’s threshold for forward guidance is “superior” and “more transparent” than a calendar date because it would signal how the committee would alter policy in line with changes in the economy, Bernanke said.
“We decided, since we were ready to go, why not make the change earlier and get the benefit earlier?” Bernanke said.
A tab on the Chicago district bank’s homepage links to two charts for inflation and unemployment underlying Evans’s 15- month campaign. Dotted lines show the Fed’s estimate for full employment and its target for price increases. The message: inflation is too low; joblessness too high.
“What Charlie would say is, ‘There’s risks of doing nothing and there’s risks of doing this, and it’s worth taking a little extra chance because in the end we have this dual mandate,”’ Eichenbaum said, referring to the Fed’s obligation to ensure price stability and full employment. To Evans, “8 percent unemployment is unacceptable.”
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