New Monetary Policy Framework an Important Milestone, Says US Fed Vice Chair

Richard Clarida stressed that the US economy has clearly evolved along several crucial dimensions since 2012.

Richard Clarida, Vice-Chair of the US Federal Reserve, said the unanimous approval and release of a new monetary policy framework marked "an important milestone", calling it a critical and robust evolution of the central bank's monetary policy strategy.

Last week, the Fed announced that it will seek to achieve inflation that averages 2 percent over time, which means following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time, reports Xinhua news agency.

Constraints on Federal Open Market Committee

Speaking at a virtual event on Monday, Clarida stressed that both the US economy and the Fed's understanding of it have clearly evolved along several crucial dimensions since 2012, with the most significant change being the decline in neutral real interest rate and thus the neutral policy rates.

US Banknotes
Representational Picture Xinhua/Liu Jie/IANS

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.

New Approach Approved by Central Bank

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.