(Adds quotes from Williams, monetary policy background)
By Ann Saphir
BERKELEY, Calif. Nov 21 The U.S. Federal
Reserve and other global central banks may need to consider new
tools in a world of permanently lower interest rates, including
keeping big balance sheets or using negative interest rates to
combat shocks, a top Fed official said on Saturday.
With the so-called natural interest rate in the United
States now near zero, and equilibrium rates in other countries
around the world also lower than in the past, central banks have
"significantly less room to maneuver" in the face of recessions,
San Francisco Fed President John Williams said at a conference
at University of California Berkeley's Clausen Center.
The natural interest rate is the rate at which an economy
can maintain its balance, with full employment and stable
inflation. Central banks traditionally aim to cut interest rates
below that level to stimulate their economies, but have less
room to do so when the natural rate is low.
The Fed's balance sheet swelled to more than $4 trillion
after the 2007-2009 financial crisis and recession as the U.S.
central bank bought up bonds in order to push down borrowing
costs and stimulate investment and hiring.
Most observers, and Fed officials themselves, believe the
central bank will eventually trim the balance sheet back to
pre-crisis levels at around $800 billion.
But in the context of low natural interest rates worldwide,
Williams said, large balance sheets could effectively give
central banks a bigger interest-rate buffer with which to combat
"You could think about keeping a permanently higher balance
sheet, lowering the term premium and therefore actually raising
the natural rate of interest in the economy," Williams said. The
idea, he said, is "something that we haven't studied that much,
but I think needs a lot more thought."
Central banks may also want to consider using negative
interest rates in some situations, he said, an option that
several central banks in Europe have already tried.
One other possible central banking tool would be to loosen
policy by targeting higher inflation rates, Williams said,
although the effectiveness of such a move is unclear given
stubbornly low inflation rates worldwide and the inability of
many central banks, including the Fed, to reach even their
current inflation targets.
Because lower worldwide natural rates mean central banks are
potentially less effective than before, fiscal policymakers
should also consider new approaches, Williams said, including
perhaps putting in place automatic tax cuts that could go into
effect if the jobless rate surges.
(Reporting by Ann Saphir; Editing by Alan Crosby)