Low rates and high anxiety at Jackson Hole

Posted on August 25, 2016

Members of the Fed Up Coalition protest during the Jackson Hole economic symposium, sponsored by the Federal Reserve Bank of Kansas City, at the Jackson Lake Lodge in Moran, Wyoming, U.S., on Thursday, Aug. 27, 2015. The symposium gathers central bankers, finance ministers, academics, and market participants to discuss the theme of "Inflation Dynamics and Monetary Policy". Photographer: David Paul Morris/Bloomberg©Bloomberg

Members of the Fed Up group protest during the Jackson Hole economic symposium

    The opening event for many of the central bankers gathering for their annual symposium in Wyoming this year is not an academic address on monetary policy but a meeting with a coalition of left-leaning activists.

    Eight top US policymakers, including Bill Dudley of the New York Fed and Lael Brainard, a Fed governor, are due on Thursday to sit with representatives of the Fed Up group, among them workers on low wages from around the country.

    They are likely to hear warnings against higher official interest rates and complaints that the central bank’s leadership is insufficiently diverse.

    The dialogue, presided over by Esther George, the Kansas City Fed chief, will mark a highly unusual start to the gathering in Grand Teton National Park normally dominated by esoteric debate about monetary policy.

    But Fed Up’s demands that the US central bank hold off lifting interest rates will strike a chord with at least some of the Fed policymakers.

    Underlying this year’s Jackson Hole retreat is a growing recognition that, after dismayingly sluggish economic recoveries following the financial crisis, interest rates are set to remain low for far longer than policymakers predicted. Many are now asking whether they have the right tools to fight the next downturn.

    “We are now seven years removed from the crisis and we still have below-target inflation in most major economies, and only the US is approaching full employment,” said Ethan Harris, head of global economics at Bank of America Merrill Lynch. “Central bankers have to face much tougher questions now.”

    The Fed’s next move

    For Wall Street investors, the main event in Jackson Hole will not be the Fed Up meeting but an address by Janet Yellen, the Fed chair, who will speak on Friday morning.

    Some of Ms Yellen’s colleagues have been explicitly trying to prod markets into pricing in the possibility of a near-term increase, among them Mr Dudley and John Williams, the president of the San Francisco Fed. Stanley Fischer, the vice-chairman of the Fed’s board of governors, also sounded a hawkish note this week when he said the Fed was on the cusp of hitting its targets.

    Stanley Fischer, vice chairman of the U.S. Federal Reserve, speaks during a Bloomberg Television interview in Washington, D.C., U.S., on Monday, Aug. 10, 2015©Bloomberg

    Stanley Fischer, Fed vice chairman, says the Fed is on the cusp of hitting its targets

    However, many policymakers will want to see the next set of payrolls numbers before making up their minds about September, and Ms Yellen may be reluctant to publicly pre-empt what looks likely to be a close decision. Minutes to the Fed’s latest rate-setting meeting suggested that policymakers were divided over the wisdom of a near-term move.

    Central banking ammunition

    The thrust of Ms Yellen’s speech is about the Fed’s toolkit, suggesting that she wants to focus more on longer-term questions of how the Fed will conduct monetary policy.

    That chimes with the theme of the Jackson Hole conference, which is about designing “resilient monetary policy frameworks for the future”. Central bankers are asking whether they have enough firepower to fight the next recession. Given official rates remain at near-zero levels, there will be little scope for rate cuts to be used as stimulus.

    Lewis Alexander of Nomura argues that, having “crossed the Rubicon” into unconventional monetary policy during the crisis, the Fed is now having to question whether it can simply move back to its old framework. Among the issues is whether it may need to maintain a significantly larger balance sheet than it did before it started its quantitative easing programme.

    You need JavaScript active on your browser in order to see this video.

    No video

    Another is whether the 2 per cent inflation target the Fed pursues is the right one in the context of stubbornly low growth and a depressed neutral rate of interest.

    Mr Williams, the San Francisco Fed president, teed up this theme in August with an essay arguing that central banks might need to shoot for higher inflation to give themselves more leeway in the next downturn.

    Negative rates

    One of the most controversial tools up for debate is the use of negative interest rates, which are being deployed in the euro area and Japan with mixed effects.

    Some economists argue that central banks need to accept these as a far more routine part of their frameworks and are seeking ways to allow rates to be cut to far deeper negative territory.

    The European Central Bank and Bank of Japan have both pushed rates below the zero lower bound, and the central banks of Switzerland, Sweden and Denmark have also deployed negative rates to battle low inflation and subpar growth.

    However, worries have since grown about the policy’s impact on bank profitability, as well as the confidence-damping signal that their use sends. The ECB has acknowledged that if rates went too far into negative territory the damage to banks could undermine the expansionary effects.

    Ms Yellen has refused to rule out the use of negative rates in the US in a “very adverse” scenario, but she has suggested that they would not be her first choice of instrument.

    A recent Fed paper by David Reifschneider was relatively optimistic about policymakers’ ability to stimulate growth via forward guidance and asset purchases when they had little scope to cut rates.

    The neutral rate of interest

    Federal Reserve Board Chair Janet Yellen smiles as she testifies before the Senate Banking Committee at Capitol Hill in Washington, U.S., June 21, 2016. REUTERS/Carlos Barria©Reuters

    Janet Yellen, the Fed chair, will speak on Friday morning

    Behind discussion about new monetary tools is a big shift in thinking about longer-term growth.

    Following the lead of economists including Lawrence Summers, the former treasury secretary, some analysts now argue that ageing populations, slower productivity growth and a reluctance around the world to spend and invest have propelled advanced economies into so-called secular stagnation.

    One of the implications is a low neutral rate — the rate of interest that is neither stimulative nor restrictive for the economy. That in turn means that in the US the Fed’s target rate is unlikely to be lifted very far.

    Reconciling that conclusion with a view that short-term rates still need to be increased this year presents an undoubted communications challenge for the Fed.

    For the activists at Fed Up worried about low wage growth, arguments for near-term rate rises seem very thin indeed.

    The fact that so many Fed policymakers are meeting them this year shows how wary the central bank is of appearing out of touch with those concerns.

    You must be logged in to post a comment Login