If there is one thing the history of the Fed has taught us, is that every boom eventually results in a painful bust.
That, however, is not the way Janet Yellen sees things. The former Fed chairman, who last June said she doesn’t believe that “we will see another crisis in our lifetime”, urged the Fed to commit to a new approach to forward guidance, one which would let economic booms run long enough to fully offset crashes like the global financial crisis, recommending that the Fed make “lower-for-longer” its official motto for interest rates following serious downturns.
Of course, by doing so, the Fed also ensures that the subsequent crash would be far more serious, but Yellen’s “strategy” is cunning: all the Fed would have to do is blow an even larger bubble as a result, guaranteeing an even greater wealth transfer during the next “recovery.”
What Yellen’s “new” approach boils down to is basically for the Fed to let the economy overheat, and let inflation run rampant as a result of looser monetary policy while shunning concerns about financial stability risks, even after a decade of low rates.
Of course, her logic presented in typical academic central banker fashion was far more simplistic: elaborating on how the central bank should think about what to do not if but when rates have to be cut to zero again in the future and can’t go any lower, she said the Fed should promise now that it will keep rates low enough to let a hot economy make up for lost time.
“By keeping interest rates unusually low after the zero lower bound no longer binds, the lower-for-longer approach promises, in effect, to allow the economy to boom,” Yellen said her most extensive remarks about monetary policy since leaving the Fed early in the year delivered at a Brookings Institution conference. “The (Federal Open Market Committee) needs to make a credible statement endorsing such an approach, ideally before the next downturn.”
In other words, the Fed should short circuit the business cycle entirely, not just prolong it with the help of the ECB and BOJ, making a downturn virtually impossible.
Of course, Yellen’s strategy is hardly novel and reflects current Fed policy, which was largely set before Yellen left office. Officials, for example, view their 2 percent inflation target “symmetrically,” and say they are willing to tolerate inflation a bit higher than that without overreacting, just as they were willing to tolerate inflation a bit weaker.
However, the former Fed chair went beyond merely the Fed’s traditional 2% inflation target, which it recently surpassed, and is urging Powell to go a step beyond, adopting a metric, “whether a measure of lost output, the sum of below target inflation, or some other measure” that it would hit before raising rates too high, if at all.
Oddly, the stock market was not mentioned as an indicator of overheating and/or frothiness in the market which is strange since due to reflexivity most modern recessions start with the market and only then flow through the economy, something the Fed has been all too aware of ever since Ben Bernanke targeted the wealth effect with his famous Washington Post op-ed nearly a decade ago.
Ultimately, Yellen is merely trying to give the Fed more leeway to keep rates “lower for longer”, even when both its mandates, employment and inflation, have been met. Like right now.
Yellen also claimed that by making a “strong, official commitment” to making up lost ground, the Fed could raise expectations about inflation and growth, and more effectively stoke the economy without taking some of the risks involved with other schemes, such as formally raising the inflation target higher than 2 percent.
The Fed could “emphasize that it anticipates that the additional stimulus provided by this approach will result in a period of exceptionally low unemployment and that inflation would likely overshoot … perhaps emphasizing the desirability of compensating for a previous shortfall … It could articulate that the FOMC’s objective is to achieve inflation near 2 percent, on average, over the business cycle.”
As Reuters adds, central bankers globally are grappling with the fact that interest rates in general may be lower than they have been in the past, meaning policy rates may hit zero more often and erode the influence of monetary policy in recession fighting.
What about more QE, or even buying stocks during the next depression? Yellen said that should remain an option when policy rates hit zero, but did not think it sufficient to battle another severe recession. Rather, the Fed should make a promise that households and markets believe it will meet.
It was not clear what promise the Fed can make to households that would make them forget that the Fed’s disastrous policies have resulted in yet another economic and market collapse, and – if Yellen has her way – a collapse that will only be far worse the next time around.