Japan has not recovered fully from the lost decade of the 1990s. The Asian financial crisis was exacerbated by the dot-com crash and then a few years later the global economic collapse. Tokyo has tried everything to combat anemic growth and deflation and resolve the zombification of the Japanese economy through an immense buildup of government debt and a dramatic loosening of monetary policy, including subzero interest rates. This has become known as Japanification. In recent years, Europe has seen its own Japanification, and now it looks like the United States could mirror it, too.
This past summer, Federal Reserve Chair Jerome Powell rejected unsound advice from some of the world’s top economists when he dismissed a proposal to raise the inflation target rate from the current 2% to 4%. Proponents of this policy say it would allow the central bank to cut interest rates before they slide to zero, giving the central bank and the overall economy a whole new set of problems. Powell conceded that it was not “a practical alternative” and wondered “how credible that would be.”
It looks like some Fed minds found a compromise: temporarily boosting the inflation target rate.
Since it listed 2% as the key rate to hit in 2012, the Fed has had a difficult time meeting that objective. Policymakers are getting fed up with the Fed’s inability to get inflation to reach their target, despite the unemployment rate hitting a 50-year low.
As part of its annual review of monetary policy tools, the Fed is contemplating increasing its aim to grapple with its lackluster inflation, the Financial Times reported. Citing current and former Fed policymakers, the newspaper suggests that the Fed is thinking about temporarily raising its goal when it misses its inflation target. This would allow the Fed to make up for lost inflation and prevent prolonged low U.S. price growth.
How are current and former Fed officials reacting?
Ex-Fed Chair Janet Yellen thinks it is “a worthwhile thing” to discuss, positing that it would be similar to its forward guidance used in the early post-recession days. At the time, the central bank informed markets that it planned to keep short-term rates low for a significant period. Before finishing her tenure at the Fed, she admitted that she was open to the possibility of raising the 2% range.
Former Fed Vice Chair Stanley Fischer conceded that he opposes a 4% target rate because then unions would want to tie their wages to inflation.
Lael Brainard, a member of the Fed Board of Governors, stated that she prefers something a bit more flexible, recommending that the range could increase from 2% to 2.5% after several misses. As long as you are communicating to the public – financial markets, households, and businesses – about what you are doing, then the rules could work effectively, she noted. At the same time, Brainard also believes that the subject is too complex to share presently with the public.
Fed Bank of Boston President Eric Rosengren says it is important to let markets know that you cannot have readings only below 2% to meet the target inflation rate. He also believes that this formulaic approach would concern financial markets.
“This is why I prefer something that is a little bit more flexible, maybe not as constraining, but makes it a little clearer that we should be having over 2 percent,” Rosengren told the Times.
Are Negative Rates Next?
Everything about the way governments and central banks report inflation is egregious. They usually underreport, so price inflation is likely higher than what is being touted. For the sake of analyzing what the Fed is doing, let us suppose that the inflation rate is what the establishment says it is.
A key argument against this idea is that the fed funds rate is already at historic lows. In the next recession, monetary policy would largely be ineffective unless it torches long-term sustainability by introducing subzero interest rates to spur growth. This would be the death knell of the world’s largest economy since negative rates signify that the Fed has exhausted all tools at its disposal.
Others make the argument that inflation expectations would be lower under this scheme. Could the United States experience its own Japanification? Despite a myriad of monetary stimulus measures to reverse these trends, nearly everything employed has failed – it appears negative rates will not stave off Japan’s upcoming recession. Instead, these efforts have sent bond yields lower, created bad bank loans, and increased debt levels.
An Empty Tank
Is the tank empty? Like the European Central Bank (ECB) and the Bank of Japan (BoJ), everything the Fed does will largely be ineffective during the next recession. During the boom phase of the business cycle, the central bank has cut rates, expanded the money supply, and relaunched quantitative easing (QE) by scooping up billions in Treasuries and injecting credit markets with cash. What else could the Fed do? Negative rates seem the next logical step. What is clear is that the Fed is making up strategies as it goes along, sacrificing long-term gains for immediate survival and instant gratification.
Read more from Andrew Moran.