Dallas Federal Reserve Bank President Robert Kaplan says the Fed is “quite a ways” from considering raising interest rates, but advocated “restraint” in doing more to stimulate the economy.
Although inflation has long run below the Fed’s 2% target, Kaplan said he is “cognisant” of the possibility that inflation could accelerate in coming years. He said the central bank needs to be aware of the impact of its expansive monetary policies on financial stability and the value of the dollar and not do more than necessary. He also strongly suggested in a telephone interview Wednesday that the Fed should not do more “quantitative easing” at this time, given its near zero interest rate stance and its multiple special lending facilities.
Kaplan, a voting member of the Fed’s policy making Federal Open Market Committee said he is “open” to allowing a “moderate overshoot” of inflation under certain circumstances, but said he would oppose making a “commitment” to achieving some average of inflation as part of its monetary “forward guidance.”
Although the economy has recovered, it has not recovered as fast as he had hoped because of the persistence of the coronavirus, Kaplan said. Instead of growing at a percentage in the high 20s in the third quarter, he said it is more likely to grow closer to the low end near 20%. For the year, he projects a 4.5% contraction and says unemployment could end the year between 8% and 8.5 %.
Because the economy continues to struggle, the federal government needs to continue to provide “relief” in the form of extended unemployment benefits and fiscal support for state and local governments, he said, however, he added he is very hesitant to support additional monetary stimulus. “The number one stimulus” must be virus control, he said.
Although the Fed has continued to hold the federal funds rate in a zero-to-25 basis-point target range since March, it has slowed the pace of its bond purchases. Asked whether the Fed needs to pick up the pace of its asset purchases or “quantitative easing,” Kaplan demurred. “I’d want to withhold judgment at this point, because we’re doing one other thing which may not show up on our balance sheet, but it’s having a big effect, and that is these (Section) 13-3 programs.- the programs to help stabilise the corporate bond market, municipal finance market, the money market fund markets, asset backed securities markets,” he said.
“One thing about those programmes is we haven’t put out a lot of money relative to our capacity,” he continued. “The municipal finance program is an example. The take-up is a small fraction but those are meaningful policy steps, and what we’re doing in the corporate bond market to help backstop corporate credit, even though we’re not using a lot of money we still have got a contingent obligation that I think is helping to stabilise those markets and cause them to be very robust, and that’s why we’ve seen so much issuance.”
“So actually the amount of stimulus the Fed is providing is bigger than you can tell just from rates and from the size of our balance sheet and that a number of these 13-3 programs are actually not showing up in the balance sheet because there’s hasn’t been that much take up,” Kaplan maintained. “But that doesn’t mean they’re not very significant. I think they’re having a very significant impact.”
Kaplan contended, therefore, that the Fed show go slow in introducing any additional monetary stimulus. “And so at this point , with as much as we’ve done, I think I’d rather wait and turn over a few more cards to see how we’re managing the virus and how the recovery is unfolding,” he said. “And I’d’ rather hold off until we see more information to see whether it’s necessary to do more, because I’m one who thinks that when you include what we’re doing with the 13-3 programs we’re doing a substantial amount.”
While emphasising the importance of supporting economic growth to reduce unemployment in wake of the virus-induced recession, Kaplan is also keeping an eye on inflation, as well as asset prices and the value of the dollar, as he evaluates appropriate monetary strategy. Last week, the Labor Department announced a 0.6% upsurge in the core Consumer Price Index, biggest since January 1991, and Kaplan was slower to label the rise as transitory than some.
“There are conflicting things going on,” he observed. “On the one hand, for certain items there is actually significant price pressure – lumber, food items. Some of it is due to supply constraints.”
He said the inflation picture is complicated by forces such as technological innovations that have sped delivery of goods and services and limited “pricing power” for competing businesses, as well as globalisation and excess capacity in a recessionary economy. “Those who say, ‘Gee, weak dollar, higher commodity prices, this is inflationary,’ I don’t disagree with them,” he said. “But the only comment I would make, there are other forces in addition that are also powerful that are also unfolding, and we’ll just have to see how they interact with each other.”
While Kaplan expects headline inflation to be “muted” “in the short to medium term,” he is much less confident it will remain so beyond that time frame. “As you get past the next year or two and as the unemployment rate starts to come down and we get closer to full employment, I think when I look at the weakness in the dollar – and we’ll have to see how some of these structural factors play out – I am cognisant of the possibility that inflation dynamics may look very different than they did for the last 10 years.
“I don’t know that they’re going to necessarily unfold in the same way,” he went on “So it’s possible we’re going to have stronger inflation at similar levels of unemployment than we have over the last few years. But the truth is, I don’t know, and it’s something we’re cognisant of and we’re monitoring very, very carefully, ” he added. “My own caution is I wouldn’t assume the future is going to look like the past.”
During the financial crisis of 2008-09 and during the current recession, the Fed has been able to depend on low, well-anchored inflation expectations as it took aggressive and unprecedented steps to spur growth. But some have warned the Fed’s dramatic money creation in recent months could unhinge inflation expectations, undermine the Fed’s credibility and set the stage for hyperinflation and a collapse of the dollar.
Responding to such concerns, Kaplan took pains to note that the Fed’s special liquidity and credit programs are currently scheduled to lapse after Dec. 31. “They’re not going to go on indefinitely.”
Kaplan said, “It’s very important to communicate to corporate bond markets and other bond markets that these programs are going to sunset. I think it’s very critical that we not build in a degree of reliance on the continuation of these Fed programs any longer than we need to.”
The same kind of financial market concerns about inflation and the dollar make him reluctant to project more QE.
“This is part of the reason why…I would rather wait, because I would rather show some restraint at this point to see what more might be necessary, because I would prefer not to do any more than is necessary, because, yes, I am sensitive to the impact of our 13-3 programs, QE as well as rates at this low level – the impact that has on risk assets and also the impact it could have on the dollar and potential inflation pressures down the road.
“I don’t know that I can accurately predict what the world is going to look like two to five years from now, but part of my approach is to emphasise that I think there is a meaningful probability that the world may look different a couple of years from now than it has in the last 10 years in terms of inflation,” he elaborated. “And to me it causes me to want to show some restraint here in terms of what we do next because of the unpredictability of that dynamic.”
At the same time, Kaplan said he thinks it’s too early to think about “normalising” monetary policy, noting that when he submitted his projections for the mid-year Summary of Economic Projections, with its funds rate “dot plot,” he personally projected that the funds rate would need to be kept in its current target range through the end of next year.
Kaplan could not say when it might be appropriate to leave the zero lower bound, but said he “would want to see us make substantially more progress on reaching our full employment objectives, and we’re a long way from that right now as well as our inflationary objectives before I would consider taking steps to adjust monetary policy”.
“I reserve the right to update my views,” he went on, adding that any changes in his view will be “a function of what’s my assessment as this unfolds of the prospects of reaching full employment and over what time frame and what are the prospects for inflation.
“During this period you’re going to see me be very vigilant and cognizant of how things are unfolding,” he added. “On the margin, at least…I think what we’ve done up until now in this crisis was appropriate and necessary,” he said, “but I personally am going to advocate for restraint from here in advocating for doing more.”
While cautious about “doing more,” Kaplan said he is far from contemplating monetary “normalisation.”
“At this stage…I’m quite a ways from saying we should be making adjustments or even where I can see the point of where we’ll be making adjustments to the fed funds rate,” he said, “but I think in the short run, at a minimum, I don’t want to do any additional steps than are necessary to help foster the recovery, and right now I think for me the jury is out about how much more we need to do.
“We’ve done a substantial amount, when you include 13-3, and that’s very much in my mind,” he added.
Although he expects consumer price inflation to remain muted for a couple of years, Kaplan suggested the Fed needs to weigh potential asset price inflation and in turn financial instability. “One of the reasons why I say I’d like for us to show restraint…and don’t want to do more than we have to is because when you’ve got the impact of our actions on risky assets, you can encourage people inadvertently or unwittingly to take more risks, to leverage more and create excesses and imbalances that are hard to see as they’re building but can be very painful to deal with.”
Already, before the Covid crisis, Kaplan noted that the Fed had to cope with the consequences of “embedded leverage” in financial markets. Minutes of past FOMC meetings strongly suggest the Committee is moving toward some form of inflation averaging, under which the Fed would permit inflation to overshoot its 2% target for a time to compensate for earlier undershooting of the target.
Kaplan seems to be on board, but seems not as wedded to making an average inflation target a hard-and-fast part of monetary “forward guidance” as some of his colleagues. “I am on one hand willing and open to consider overshoot of our 2% inflation target in the aftermath of a period running persistently below 2%,” he explained. “However, that is not a commitment to take action.”
He said he’d be willing to support an average inflation target, provided it was conditioned on “in the circumstances,” including what’s going on with employment. He said the Fed would also need to “take into account financial stability concerns.”
Regarding economic conditions, Kaplan acknowledged that recent economic indicators, including the July purchasing managers surveys, had been robust, but said the economy is “just not as good as we would have had if we had had better control of the virus.” Because of the virus, he said consumers had pulled back and caused the recovery to “stall” somewhat since mid-June.
Going forward, Kaplan said he will be looking closely at “high-frequency” data, including “mobility” and “engagement” gauges, such as cell phone usage.
The Dallas Fed has its own Mobility & Engagement Index. (https://www.dallasfed.org/research/mei.aspx).