Fed May Introduce Threshold on its Monetary Policy

By TraderVox.com

Tradervox.com (Dublin) – Federal Reserve have been seen as shifting from its current strategy of tying monetary policy change to the calendar to linking it with specific economic conditions such as reduction in unemployment rate. In its September 12-13 meeting, the Fed extended its time horizon of keeping close to zero rates from late 2014 to middle 2015, which some members expressed their concerns that it would be construed as a downgrade on their economic outlook. Its decision to add stimulus has been met with resentment from several quarters with skeptics saying it will not achieve the desired results.

James Hamilton, who is a Professor of Economics in San Diego at the University of California, noted that the benefits of numerical guidelines or thresholds on the monetary policy would be that the public would understand the reason why the Fed is keeping interest rates low. Hamilton’s research on effectiveness of alternative policy tools that can be used by the Fed have been cited by Fed Chairman Ben S. Bernanke in several speeches. Hamilton’s views have also be echoed by Chicago Fed President, Charles Evans, who said that it is critical for the central bank to promise to keep interest rates low until unemployment hits 7 percent and inflation does not exceed three percent.

Other members of the FOMC have agreed that such a strategy would give the Fed flexibility to tackle changing economic issues. However, most of them expressed their concerns on reaching a consensus on specific thresholds as they have very diverse views on this subject. However, James Bullard, the St. Louis Fed President, said that introducing threshold would limit the central bank’s leeway, indicating that threshold would “put the committee in a box.”

According to the minutes of last month’s FOMC meeting, policy makers are expecting to change the size of the asset purchases program to reduce risks associated with the plan if these risks become eminent and detrimental to the economy.

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