With a diminished reservoir of conventional policy space, it is much more likely than was appreciated in 2012 that, in economic downturns, the effective lower bound (ELB) will constrain the ability of the Federal Open Market Committee (FOMC), the Fed's policy-making body, to rely solely on the federal funds rate instrument to offset adverse shocks, Clarida said.
In the past several years of the previous expansion, declines in the unemployment rate occurred without a surge in price inflation to a pace inconsistent with the Fed's price-stability mandate and well-anchored inflation expectations, according to the Vice Chairman.
The Fed's new framework noted that policy decisions going forward will be based on the FOMC's estimates of "shortfalls of employment from its maximum level," not "deviations", which means that the central bank won't raise interest rates simply because unemployment has fallen to a low level, Clarida said.
Clarida said the new approach was unanimously approved by the central bank following a yearlong review of its monetary policy framework.
"This is a robust evolution in the Federal Reserve's policy framework and, to me, reflects the reality that econometric models of maximum employment, while essential inputs to monetary policy, can be and have been wrong."
As to other monetary policy tools,he reiterated that FOMC members do not see negative policy rates as an attractive policy option in the US context, and with credible forward guidance and asset purchases, the potential benefits from yield curve controls may be modest.
(Only the headline and picture of this report may have been reworked by the Business Standard staff; the rest of the content is auto-generated from a syndicated feed.)
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