Nominal interest rate

Average Inflation Targeting

The Federal Open Committee’s first-ever comprehensive monetary policy review looks to be coming to an end. Since the announcement on November 15, 2018, the Fed has focused on strategies, tools, and communications practices, and engaged the public through numerous Fed Listens events, including a conference at which invited experts proposed new approaches (see our earlier post). At its July meeting, the FOMC discussed potential changes to its Statement on Longer-Run Goals and Monetary Policy Strategy—the “foundation for the Committee’s policy actions”—with the aim of finalizing those changes soon. And, Chairman Powell is scheduled to speak this week about the “Monetary Policy Framework Review” at the annual Jackson Hole Economic Policy Symposium.

Perhaps the most important issue on the review agenda is the FOMC’s inflation-targeting strategy. Since 2012, the FOMC has explicitly targeted an inflation rate of 2% (measured by the price index of personal consumption expenditures). A key objective of FOMC strategy is to anchor long-term inflation expectations, contributing not only to price stability, but also to “enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances.” Yet, since the start of 2012, PCE inflation has averaged only 1.3%, prompting many policymakers to worry that persistent shortfalls drive down expected inflation (see, for example, Williams). And, with the Fed’s policy rate now back down near zero, falling inflation expectations raise the expected real interest rate, tightening financial conditions and undermining policymakers’ efforts to drive up growth and inflation.

In this note, we discuss one alternative to the current approach that has gained wide attention: namely, average inflation targeting. The idea behind average inflation targeting is that, when inflation falls short of the target, it creates the expectation of higher inflation. And, should inflation exceed its target, then it would reduce inflation expectations. Even when the policy rate hits zero, the result is a countercyclical movement in real interest rates that enhances the effectiveness of conventional policy….

Read More

Negative Nominal Interest Rates: A Primer

Many people find negative interest rates confusing. Why should anyone pay a bank to make a deposit? Why should a bank pay someone to borrow? How can we value an asset with a future cash flow when the interest rate is negative?

Policymakers also wonder whether the effects of negative interest rates on the economy are favorable or unfavorable. Do negative interest rates help central banks achieve price stability by stimulating economic activity? Do negative rates spur banks to make more good loans or to evergreen bad ones? Will borrowers and banks take on too much risk because they can fund investments at a negative rate? Will households reduce their saving rate because the return is so low, or raise it because low returns leave them farther from their wealth target? Will negative rates influence the ability of pension funds, insurance companies and governments to make good on their long-term promises to future retirees?

In this primer, we examine these questions, starting with key facts about negative nominal interest rates. Our conclusion: there is little magic about having a slightly negative, as opposed to slightly positive interest rates. Thus, much of the criticism of persistently negative nominal interest rates applies similarly to very low, but positive rates. That said, financial system frictions limit the favorable impact from modestly negative nominal rates, but our experience with them remains limited. Given the likely need for unconventional policy tools to address the next recession, learning more about the benefits and costs of negative nominal interest rates is a high priority….

Read More

Trump v. Fed

Last month, interrupting decades of presidential self-restraint, President Trump openly criticized the Federal Reserve. Given the President’s penchant for dismissing valuable institutions, it is hard to be surprised. Perhaps more surprising is the high quality of his appointments to the Board of Governors. Against that background, the limited financial market reaction to the President’s comments suggests that investors are reasonably focused on the selection of qualified academics and individuals with valuable policy and business experience, rather than a few early-morning words of reproof.

Nevertheless, the President’s comments are seriously disturbing and—were they to become routine—risk undermining the significant benefits that Federal Reserve independence brings. Importantly, the criticism occurred despite sustained strength in the economy and financial markets, and despite the stimulative monetary and fiscal policies in place….

Read More

How much is our distant future worth?

In the first Superman movie, released in 1978, Lex Luthor, the supervillain played by Gene Hackman, buys up large swaths of real estate in the deserts of eastern California and Nevada. His plan is to hijack a nuclear missile and use it to cleave off coastal California into the Pacific Ocean, leaving him with newly valuable beach-front property. Well, maybe all Lex really needed was patience, not a nuclear device...

Read More

Inflation Expectations: How Credibility Pays Off

Monetary policymakers always worry about inflation expectations. They can’t directly observe what households and business anticipate for the future path of prices, so they construct estimates from market prices and surveys. Why do they care so much? The reason is simple: keeping inflation expectations low and stable is the first step to keeping inflation low and stable. It also makes the economy more resilient in the face of adverse shocks...

Read More