Two heavyweight Fed papers argue for stronger policy action
WASHINGTON Nov 5 (Reuters) - Two of the Federal Reserve's top staff economists make the case in new research papers for more aggressive action by the U.S. central bank to drive down unemployment by promising to hold interest rates lower for longer.
The papers provide valuable insight into the central bank's thinking at a time when Fed Vice Chair Janet Yellen is maintaining strict silence ahead of a Senate hearing on her nomination to succeed Chairman Ben Bernanke in January.
The studies were authored by teams led by William English, head of the Fed's monetary affairs division, and David Wilcox, the central bank's director of research and statistics. They will be presented at an International Monetary Fund conference in Washington on Thursday and Friday, respectively.
The Fed has kept interest rates near zero since late 2008 and has vowed to hold them there at least until the unemployment rate hits 6.5 percent, provided the outlook for inflation does not rise above 2.5 percent. The U.S. jobless rate was 7.2 percent in September.
"The studies suggest that some of the most senior Fed staffers see strong arguments for a significantly greater amount of monetary stimulus," Goldman Sachs Chief Economist Jan Hatzius wrote in a research note to clients. His takeaway was that the Fed would likely lower the unemployment threshold to 6.0 percent at its March meeting.
The paper co-authored by English studied what would happen if the Fed strengthened this so-called forward guidance.
It found that economic benefits were higher when the unemployment threshold was 6.0 percent, compared to 6.5 percent, and higher still if it was 5.5 percent compared to 6.0 percent. It did not find much evidence to support altering the inflation threshold, as some have advocated.
The paper co-authored by Wilcox examined evidence that the costs of high unemployment on the productive capacity of the U.S. economy were much larger than thought, strengthening the argument to allow inflation to overshoot the Fed's 2 percent target to bring the level of joblessness down faster.
Both papers discussed a so-called optimal policy path, echoing the findings Yellen herself laid out in a speech last year that urged policy forbearance if inflation temporarily overshot the Fed's price stability objective.
Yellen can expect to be quizzed about this view at a Senate Banking Committee hearing that is likely to be held on Nov. 14.
Other economists were not so sure the Fed will lower its unemployment threshold, since the English paper also discussed the costs to the central bank's long-term credibility of changing the thresholds.
But they agreed that neither paper advocated heavily for the Fed's bond-buying program, which has quadrupled the size of the central bank's balance sheet to $3.8 trillion in an effort to hold down long-term borrowing costs.
Officials have already said they would like to start scaling the program back, but stunned markets in September when they opted to keep buying bonds at an $85 billion monthly pace. They maintained that stance at a meeting last week.
The emphasis on the benefits of stronger forward guidance in the paper by English and his two colleagues, however, suggested that officials may at least opt to give more clues about how they would respond as the U.S. jobless rate nears their current 6.5 percent threshold.
This could be done when Fed policymakers decide to begin reducing bond purchases to help offset any adverse market reaction by showing a commitment to keep interest rates low.
Bernanke, whose term expires at the end of January, told reporters in September that there were a number of ways in which the forward guidance could be strengthened.
"We could provide more information about what happens after we get to 6.5 percent and those sorts of things, and to the extent that we could provide precise guidance, I think that would be desirable," he said.
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