RICHMOND, Va. (Reuters) - A top Federal Reserve official said on Wednesday she wants to explore whether the central bank, in a future downturn, should begin targeting explicit levels for longer-term interest rates as a way to add more stimulus to the economy.
While not endorsing the use of such a strategy, Governor Lael Brainard said she “would like to hear more about” it as the Fed continues a broad review of how it conducts monetary policy.
If the short-term rates typically controlled by the Fed must again be cut to zero, as they were in the 2007 to 2009 financial crisis and recession, Brainard said the Fed under this method would use its power to purchase securities in order to hit specified levels for one-year, 2-year and other interest rates.
“Once the short-term interest rates we traditionally target have hit zero, we might turn to targeting slightly longer-term interest rates — initially one-year interest rates, for example, and if more stimulus is needed, perhaps moving out the curve to two-year rates,” Brainard said at an event with community leaders in Richmond. “Under this policy, the Federal Reserve would stand ready to use its balance sheet to hit the targeted interest rate.”
The Fed used its power to influence longer-term interest rates by buying Treasury bonds during the last crisis, as a way to add economic stimulus once its policy rate hit the “zero lower bound.”
But in that case it specified an amount of bonds to be purchased each month. Specifying longer term rates, by contrast, would be a new venture for the Fed, giving businesses and investors an explicit sense of where borrowing costs would be set. It is similar to the “yield curve control” policy used by the Bank of Japan.
Brainard’s call to explore that option showed how broad the Fed’s current review of its operating tools and strategies has become.
Still, Brainard cautioned that all of the ideas under debate share both strengths and potential weaknesses.
One often mentioned idea of using periods of higher inflation to “make up” for periods when inflation is weak, as it has been for the past decades, suffers from the risk that central bankers would - in the face of a faster pace of price increases - lose their nerve and not follow through during the make up phase.
“While such approaches sound quite appealing on their face, they have not yet been implemented in practice. There is some skepticism that a central bank would in fact prove able to support above-target inflation over a sustained period without becoming concerned that inflation might accelerate,” Brainard said.
Reporting by Howard Schneider; Editing by Chizu Nomiyama