Philadelphia Federal Reserve Bank President Charles Plosser said Friday the Fed’s 6.5% unemployment threshold for considering federal funds rate hikes has become “irrelevant” and said the Fed is unlikely to raise rates so long as it continues to buy assets.
Plosser, a voting member of the Fed’s policymaking Federal Open Market Committee, said in revising its “forward guidance” on the path of the funds rate, the FOMC should be motivated by a desire to provide greater “transparency,” not by a desire to provide additional monetary stimulus.
Trying to do the latter can “backfire,” he said in remarks prepared for delivery to a Monetary Policy Forum sponsored by the University of Chicago Booth School of Business.
Plosser did not express a clear preference for numerical or “qualitative” forward guidance, but said the FOMC should commit itself to a “prescribed reaction function.”
Since December 2012, the FOMC has been saying it will hold the funds rate near zero at least until the unemployment rate falls to 6.5%, so long as forecasted inflation does not go above 2.5% and inflation expectations are “well-anchored.”
Since December 2013, the FOMC has said it expects it will not to raise the funds rate until “well past” the time the unemployment rate falls below 6.5%.
With the unemployment rate currently at 6.6%, Plosser said “the 6.5 percent threshold will soon become irrelevant, and it probably is already.
“So the Committee, at a minimum, has to revamp its communications regarding the future federal funds rate path,” he said. “Given that we are still easing policy by buying assets, it is pretty clear that even though the threshold will soon come and go, the Committee is unlikely to contemplate raising rates as long as it is buying assets.”
“Put another way, the practical constraint at this point for raising the policy rate is no longer the unemployment rate but the fact that we are still buying assets,” he said, adding that “in my view, the threshold has already lost its meaning as a guidepost. It needs to be replaced with something that is more relevant and informative.”
In formulating new forward guidance, Plosser said the FOMC must decide on its objectives.
Up until now, he charged, “communication about the future path of asset purchases has, at times, been imprecise and confusing.”
The FOMC majority has favored using forward guidance – signaling that the funds rate will be kept low long after asset purchases have ended and the economy has strengthened – as a means of providing supplemental monetary stimulus. But Plosser questioned the efficacy of that strategy.
“This approach to forward guidance can backfire if the policy is misunderstood,” he said. “For example, if the public hears that the policy rate will be lower for longer, it may interpret this news as policymakers saying that they expect the economy to be weaker for longer.”
“If that is the interpretation of the message, then the forward guidance will not succeed and may even weaken current spending,” he added.
Plosser said “the FOMC has not been clear about the purpose of its forward guidance.”
“Is it purely a transparency device, or is it a way to commit to a more accommodative future policy stance to add more accommodation today?” he asked. “This lack of clarity makes it difficult to communicate the stance of policy and the conditionality of policy on the state of the economy.”
Plosser said forward guidance can be useful as “another step toward increased transparency and effective communication of monetary policy….By being more transparent about how policy will evolve as a function of economic conditions, this approach can help the public form more accurate expectations about the future path of monetary policy….”
“When businesses and households have a better understanding of how monetary policy is likely to evolve, they can make more informed spending and financial decisions,” he said. “If monetary policymakers can reduce uncertainty about the course of monetary policy, the economy is likely to perform more efficiently.”
But Plosser added that “in order to communicate something about the reaction function, you have to have one. That means in order to be successful with this approach to forward guidance, policymakers must be able to agree on how they will systematically respond to changes in economic conditions.”
However, the reaction function “need not be mechanistic,” he said. “Qualitative information about such a function and how it will be implemented can also be useful and meaningful.”
“Nevertheless, some degree of commitment to abide by the specified reaction function is necessary, if the communication is to achieve the desired result of reducing policy uncertainty and providing meaningful forward guidance,” he cautioned.