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Fed could delay rate hikes with inflation 'floor': Fed study
December 4, 2013 / 7:19 PM / 4 years ago

Fed could delay rate hikes with inflation 'floor': Fed study

SAN FRANCISCO (Reuters) - The Federal Reserve could bolster its commitment to ultra-low interest rates by ruling out a rate hike until inflation heads closer to its 2-percent goal, according to research published Wednesday by the Cleveland Fed.

The study plunges the usually low-profile regional Fed into one of the most pressing debates among U.S. central bankers: how best to keep market rates from rising to potentially growth-sapping levels once the Fed begins to withdraw its massive monetary stimulus.

Fed policymakers fret that when they begin to reduce their $85-billion-a-month bond-buying program, investors will conclude that rate hikes are not far behind, and will push up market rates farther and faster than the Fed believes is healthy for the economy.

Policymakers are therefore keen to find ways to convince markets they are serious about keeping rates low for a long time.

Wednesday’s research may add weight to arguments for adopting a so-called inflation floor. Edward Knotek II, who co-authored the study with fellow Cleveland Fed researcher Saeed Zaman, said he believes they are among the first to publish a study assessing the benefits of an inflation floor.

The study shows not just that a floor can delay the likely timing of the Fed’s rate hike, but also that “the choice of the floor matters,” he said in an interview.

Adopting an inflation floor of 1.75 percent, a promise that the Fed will not even consider raising rates until inflation is projected to breach that level, would likely delay any rate hike until the first quarter of 2016, the research showed.

An inflation floor of 1.5 percent would likely keep the Fed from raising rates only until the second quarter of 2015.

By contrast, the Fed’s current pledge to defer any rate hike until either the unemployment rate falls to at least 6.5 percent or inflation threatens to rise above 2.5 percent could result in rates rising as early as the first quarter of 2015, according to the research published Wednesday.

An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst

That’s earlier than a number of Fed officials believe is either likely or desirable.

Cleveland Fed chief Sandra Pianalto, who has announced plans to retire early next year, has not herself publicly embraced an inflation floor.

But the idea has a “few” supporters at the Fed, minutes of the central bank’s October meeting show, including most vocally St. Louis Fed chief James Bullard.

Asked about an inflation floor in September, Fed Chair Ben Bernanke said that it was “one possibility.”

Fed policymakers next meet in about two weeks.

Other policy options aimed at underscoring the Fed’s commitment to low rates include lowering the unemployment threshold for considering a rate hike to at least 6 percent and lowering the interest paid to banks on their excess reserves.

The chiefs of the Minneapolis and Chicago Feds have strongly supported the first idea; the latter has the backing of San Francisco Fed President John Williams.

More popular among policymakers, the October Fed meeting minutes suggested, is to leave the thresholds be and to instead offer qualitative guidance to markets about what conditions would prompt it to raise rates.

Providing such details, San Francisco Fed’s Williams told Reuters on Tuesday, would reassure investors rates will stay low for a long time even after the Fed stops buying bonds.

Reporting by Ann Saphir; Editing by Chizu Nomiyama

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