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Fed’s Dot Plot, QE, Average Inflation: Fed Conference Takeaways

Fed's Dot Plot, QE, Average Inflation: Fed Conference Takeaways

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The Federal Reserve wound up its two-day framework conference on Wednesday with little consensus on what can be done to better prepare for the next big recession.

The confab, hosted by the Chicago Fed, is the centerpiece of a yearlong internal review of the central bank’s approach to hitting its inflation target announced in November. Since then, the issues at hand have become more pressing. Inflation has drifted below the Fed’s 2% inflation goal and an escalating trade war has pulled forward concerns about recession risk.

Topics covered included quantitative easing, maximum employment and Fed communications -- including the dot plot.

Here’s a synopsis of major issues discussed:

What Should the Fed Do About the Dot Plot?

At the start of the conference, Fed Chairman Jerome Powell made clear he wasn’t totally satisfied with the Federal Open Market Committee’s so-called dot plot, which sets out policy makers’ projections of the future path of rates. With its focus on the median rate forecast, the dot plot emphasizes “what the typical FOMC participant would do if things go as expected,’’ he said.

As a result, “at times the dot plot has distracted attention from the more important topic of how the FOMC will react to unexpected economic developments,’’ he said. “In times of high uncertainty, the median dot might best be thought of as the least unlikely outcome.’’

In a research paper on Fed communications presented at the conference that generated a lot of buzz, Stephen Cecchetti, of Brandeis University, and New York University’s Kermit Schoenholtz, called for a major change in the dot plot. Rather than being anonymous, it should name which policy maker is making each forecast for rates and the economy, including the chairman’s dot.

In the question-and-answer period, St. Louis Fed President James Bullard argued that the paper ignored what he called a “central issue’’ -- the at times dichotomous monetary message from the dot plot and the FOMC statement, both of which are released at the same time following the committee’s meeting.

Quantitative Easing Works – Let’s Use More of It Next Time

Powell kicked off the conference with his assessment of how quantitative easing and forward guidance on the path of rates worked in the financial crisis and its aftermath: Pretty well.

“These policies provided meaningful support for demand, but they should not be thought of as a perfect substitute for our traditional interest-rate tool,’’ he said.

Two papers presented in Chicago broadly agreed with that assessment. In fact, Janice Eberly of Northwestern University, Harvard’s James Stock and Jonathan Wright at Johns Hopkins called for more concerted use of what they deemed “slope policies’’ the next time the economy enters into a recession and the Fed is forced to cut rates to zero.

“Early, aggressive action to flatten the term structure could substantially speed the recovery in the labor market and support reflation,’’ they wrote.

One big caveat: The Fed would end up with a much bigger balance sheet that might have unforeseen political and economic consequences.

University of Notre Dame’s Eric Sims and Jing Cynthia Wu likewise maintained that quantitative easing had worked in a separate paper. And they advocated that the central bank smoothly normalize its balance sheet once the stimulus was no longer needed.

Both papers also saw limited benefits from cutting interest rates below zero -- a policy the Fed looked at and rejected during the financial crisis.

There was one important voice at the conference arguing that QE didn’t work all that well: John Taylor, the Stanford University economics professor and author of an influential monetary-policy rule. “I think the evidence is quite weak that this new suite of slope policies works,” he said.

Average Inflation Targeting? Maybe Not

Going into this week’s Chicago conference, average inflation targeting seemed to have the inside track as a potential replacement for the central bank’s current practice for controlling prices. After all, the strategy -- under which the Fed aims for inflation above its 2% target to make up for undershoots, and vice versa -- had been endorsed New York Fed President John Williams.

But advocates of another approach -- targeting the growth of nominal income -- staged a mini-revolt Wednesday. After noted monetary economist Lars Svensson gave that strategy short shrift in his presentation, a trio of conference participants pointed to its advantages during the question and answer period, including Bullard.

Don’t Expect Big Changes from the Fed’s Review

While Fed policy makers maintain that they’re not prejudging the results of their yearlong framework review, they’ve telegraphed that they’re not likely to make substantive changes in how the world’s most powerful central bank carries out its business.

‘We are going to have a high hurdle for any major change to the framework,’’ Fed Vice Chairman Richard Clarida told CNBC television Tuesday.

Clarida, who has played a leading role in the review, has also said more than once that the results are likely to be evolutionary rather than revolutionary.

But he’s not spelled out exactly what that would mean in practice -- potentially leaving a lot open for discussion before the review winds up and its findings are delivered in the first half of next year.

To contact the reporters on this story: Rich Miller in Washington at rmiller28@bloomberg.net;Matthew Boesler in New York at mboesler1@bloomberg.net

To contact the editors responsible for this story: Margaret Collins at mcollins45@bloomberg.net, Alister Bull

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