San Francisco Fed President Williams in an overnight speech opines on an unintended consequence of keeping inflation low. Low inflation implies low interest rates. He notes that if the economy stumbles while rates are low it would mean that the Fed would have to employ unconventional policy again in downturn as we would quickly hit the zero bound.
Via the WSJ:
John Williams, president and chief executive officer of the Federal Reserve Bank of San Francisco, shown in April. Bloomberg News
NEW YORK—Federal Reserve Bank of San Francisco President John Williams said on Friday that central banks’ largely successful pursuit of low inflation could mean they more frequently run into periods where monetary policy hits levels of interest rates that can’t be cut further.
At issue is what central banker’s call the zero lower bound, or the point at which the central bank’s short-term interest rate has been cut to near zero. The Fed has been mired at this level since the end of 2008 and is broadly expected to remain there until the middle of next year.
To provide additional support, the Fed, like other central banks, has had to pursue unorthodox strategies to provide additional stimulus once more interest rate cuts were off the table.
Mr. Williams said flirting with this level of monetary policy could come hand-in-hand with success in keeping inflation low. “Based on the broader historical experience and potential for a lower level of the natural rate of interest, the [zero lower bound] is likely to be a recurring issue for central banks that target low levels of inflation,” Mr. Williams said.
The officials’ remarks came from the text of a speech that was prepared for delivery before a conference on inflation targeting held by the South African Reserve Bank in Pretoria, South Africa. He spoke in the wake of this week’s monetary-policy-setting Federal Open Market Committee meeting, but didn’t comment on the U.S. outlook.
Instead, he devoted the bulk of his remarks to taking stock of the broad success enjoyed by the many central banks around the world that have set inflation targets and worked to achieve the desired level of price pressures. The Fed has a 2% inflation target, although it is also charged by Congress to pursue maximum sustainable employment, creating what’s called a dual mandate.
Mr. Williams explained the challenge facing central banks is one of a changing economic landscape. On one side, many economies are likely to need a lower average interest rate to keep inflation at bay. On the other, downturns of a severity rivaling the troubles seen over recent years aren’t as uncommon as many believe. “A broad view of history teaches us that very large downturns are not only possible, they are common,” he said.
Past central-bank success at lowering inflation expectations, which in turn allow central banks to keep interest rate targets lower than they were historically, means there is less room to cut rates when deep economic trouble appearance and calls for an easier money stance.
“It is too early to judge whether this downward shift in the natural [interest] rate will endure,” Mr. Williams said. But, “if it does, then it raises the specter of the [zero lower bound] being a more frequent problem than in past decades when the natural rate of interest was higher,” given the omnipresent threat of an economic downturn, he explained.