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Evening Must-Read: Ryan Avent: Monetary Policy: Why Is the Fed Planning to Fail?

Ryan Avent: Monetary Policy: Why Is the Fed Planning to Fail?: "THE members of the Federal Open Market Committee...

...are not overly fond of being stuck at the zero lower bound (ZLB) [as they have been] since December of 2008.... Policy-making since then has been a monetary mess.... I'll put things more plainly. Central bankers should hate the ZLB. Whether or not policy at the ZLB tends to raise financial instability, the central bank simply can't do its job when its main interest rate is at zero. Since December of 2008 the Fed has failed miserably on both of its primary objectives: maximum employment and stable prices.... In a ZLB world the Fed does not do its job. That is a serious problem for the American economy and the Fed. It is quite possibly the most serious problem the Fed could conceivably have.

So why is the Fed so determined to find itself right back at the ZLB in future, assuming it ever leaves it in the first place?... The fed funds rate rose to 5.25% prior to the Great Recession and nonetheless tumbled to the ZLB. The 2001 recession was far milder, yet in battling it the Fed reduced interest rates from a high of 6.5% down to 1%.... There is plenty of uncertainty regarding precisely how much cushion one needs between the federal funds rate and the ZLB, yet we can be pretty safe in concluding that roughly four percentage points counts as 'not nearly enough'.... Let's be clear about this. The central bank can choose the inflation rate it wants... so there is absolutely no reason why the Fed ought to find itself stuck with too low a full-employment interest rate.... One would think the Fed would want to be damn sure to get well away from the ZLB....

The Fed is going to intentionally undershoot its inflation target on average over the next three years, thereby ensuring that it returns to the ZLB during the next downturn, thereby ensuring that it continues to undershoot its inflation target while also missing its maximum employment target. And one can't be completely sure, but I think the reason they intend to do this is because they fear that setting and hitting a higher inflation target would call into question their credibility...

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