At the Bank of Canada, policy is presented a fait accompli. At the Federal Reserve, the debate takes place in the light of day.
Take Minneapolis Fed president Narayana Kocherlakota’s speech Wednesday in Great Falls, Mont.
Mr. Kocherlakota, who holds one of 12 votes on the Fed’s policy committee, was pushing an idea that he thinks would improve U.S. monetary policy – something he calls his “liftoff plan.”
In essence, Mr. Kocherlakota thinks the Fed’s already rather explicit path for interest rates can be made even more so. Currently, the Fed says it “expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” Mr. Kocherlakota would sharpen that conditional pledge to say: “As long as the [Federal Open Market Committee] satisfies its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 per cent.”
Mr. Kocherlakota has emerged as an intriguing figure at the Fed.
Wall Street most closely watches Fed chairman Ben Bernanke and his two most senior deputies, New York Fed president William Dudley and Janet Yellen, the No. 2 to Mr. Bernanke at the Washington-based Federal Reserve Board. But Mr. Kocherlakota has come to embody the U.S. central bank’s shift from wariness about a third quantitative easing program to nearly full embrace at last month’s policy meeting. Last year, Mr. Kocherlakota opposed various stimulus measures. Now, he argues that the Fed should do even more.
The philosophy behind the Fed’s pledge to leave borrowing costs low, contingent on the inflation outlook, is meant to stir the animal spirits of consumers and executives. Mr. Kocherlakota believes this could be done better with a more explicit pledge. His reasoning is straightforward: If the public believes the Fed will begin raising interest rates when the unemployment rate drops to 7 per cent, it will borrow and spend less than it would if it believed the Fed would begin raising borrowing costs when the jobless rate drops to 6 per cent.
The Fed “can provide more current stimulus if people believe that liftoff will be triggered by a lower unemployment rate,” Mr. Kocherlakota said Wednesday.
The Bank of Canada deployed a similar strategy effectively during the financial crisis, pledging to keep its benchmark rate at a rock-bottom level for about a year, so long as inflation remained under control. However, the Bank of Canada benefited from having an established numerical inflation target. The Fed only recently adopted a 2 per cent target for inflation – and it lacks explicit guidance on the unemployment rate it associates with its mandate to achieve “maximum employment.”
Mr. Kocherlakota’s proposal would correct that, at least temporarily. He said recent history suggests that it’s unlikely that an unemployment rate higher than 5.5 per cent would trigger annual inflation over the medium term of more than 2.25 per cent. Mr. Kocherlakota also would make clear that the Fed would tolerate inflation that crept a quarter point above the 2 per cent target, which would mimic the Bank of Canada’s target band for inflation of 1 per cent to 3 per cent.
“My plan maintains price stability as a cornerstone while also promoting a quicker recovery,” he said.
That’s not yet the consensus view at the Fed; perhaps not even close. But Mr. Bernanke says he’s interested in further refining the Fed’s communications strategy, which currently states that policy makers intend to keep the benchmark rate near zero until at least mid-2015. Mr. Kocherlakota has time to win converts.