A Federal Reserve policymaker, who has long argued that pushing too hard to get Americans back to work risks inflation, pitched a bold proposal on Thursday to keep interest rates low until unemployment falls sharply.
The about-face by Minneapolis Fed President Narayana Kocherlakota gave a sign of how concerned the Fed is about the sluggish U.S. economy.
Kocherlakota, one of 19 U.S. monetary policymakers and a known hawk, suggested the Fed should keep rates low until the jobless rate drops to 5.5 percent. Though that would likely take four or more years, given the nation's current 8.1 percent jobless rate, he said the U.S. central bank should keep its vow as long as inflation expectations stay under control.
In separate speeches around the country, two other top Fed officials also downplayed the risk that the central bank's new and potentially massive asset-purchase plan would spark a run up in prices in the months or years to come. However, a fourth policymaker warned the Fed against aiming at any explicit jobless rate.
Last week, the Fed said it expected to keep its key federal funds rate near zero at least through mid-2015, and that it will retain such policy accommodation for "a considerable time after the economic recovery strengthens".
Moving aggressively to boost the slow U.S. recovery and troubled labor market, Fed Chairman Ben Bernanke and the policy-making Federal Open Market Committee (FOMC) also unveiled a plan to buy $40 billion in longer-term securities per month until the labor market improves substantially.
"This specificity - about an event that may not take place for four or more years - will provide needed current stimulus to the economy," Kocherlakota said in a speech in Ironwood, Mich.
Given the behavior of inflation over the last 15 years, unwanted inflation is unlikely to kick in until unemployment falls near that level, Kocherlakota told a group at the community college in this struggling former mining town.
"As long as the FOMC satisfies its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent," he said. "The FOMC can provide more current stimulus if people believe that liftoff will be triggered by a lower unemployment rate."
The U.S. economy grew just 1.7 percent in the second quarter, not enough to put a dent in the nation's jobless rate, which has remained above 8 percent for three-and-a-half years.
St. Louis Federal Reserve President James Bullard warned that unemployment was a "fickle variable" and the central bank would be wise not to target a specific level.
"It can go up and down because of labor force participation changes as has happened in recent years and even the most recent employment report, where unemployment ticked down but for the wrong reasons," he told reporters in South Bend, Indiana.
Dwindling conventional options
Fed officials are toying with the idea of giving more specific guidance on when it expects to tighten policy, for example by tying rate rises to specific levels of unemployment and inflation.
According to minutes of a meeting July 31-August 1, the Fed considered using economic yardsticks that would give financial markets a clearer picture of what policies lie ahead. The sharper focus on better ways to communicate reflects the central bank's dwindling conventional options, such as interest rates, which have been at rock bottom since late 2008.
Chicago Fed President Charles Evans, who is one of the central bank's most aggressive doves, has urged the Fed to pledge low rates until the jobless rate reaches 7 percent, unless inflation rises above 3 percent.
Economists polled by Reuters last week fingered 7 percent as the median level at which the Fed would consider halting its monthly purchases of mortgage-backed securities.
The speech on Thursday was a change in tone for Kocherlakota, who in April repeated his call for the Fed to start reversing its ultra-loose policy stance some time in the next six to nine months.
The "noted hawk now seems to be drinking the Bernanke cool-aid," TD Securities economist Eric Green wrote in a note to clients. Kocherlakota's speech "suggests greater unity in preaching the low for longer theme that Bernanke has drilled into the market."
But Kocherlakota told reporters his views had evolved. He now sees more downward pressure on inflation than he had thought at the beginning of the year, and said he also no longer thinks that permanent factors play nearly as big a role in the elevated unemployment rate as he had thought.
As long as the two-year forecast for annual inflation runs between 1.75 percent and 2.25 percent, Kocherlakota said, and long-term inflation expectations remain stable, the Fed should be seen as meeting its price stability mandate.
In the last 15 years, he said, the medium-term outlook for inflation has never breached 2.25 percent, so it is unlikely that it would do so until the jobless rate falls "considerably" below its current 8.1 percent level.
Risks and credibility
The Fed's consensus prediction for 2015 - the farthest the forecasts go out - is for a 6 percent to 6.8 percent jobless rate, well above Kocherlakota's 5.5 percent threshold.
Green, of TD Securities, said Kocherlakota's plan risks exploding the Fed's hard won credibility on stable inflation.
Also on Thursday, both Atlanta Fed President Dennis Lockhart and Eric Rosengren of the Boston Fed argued the inflation risks from the central bank's third round of quantitative easing, or QE3, are manageable and offset by the potential benefits.
"I simply came to the conclusion on a net basis that (it) would help the economy," Lockhart told reporters in Kansas City. "The potential risks associated with that were not severe and were, and will be in the future, manageable.
Lockhart - who unlike Kocherlakota and Rosengren has a vote on Fed policy this year - said the risk of a serious bout of inflation was "remote," despite critics' concerns that the dose of new liquidity into the economy could stoke higher prices.
In the 12 months through August, overall U.S. consumer prices increased 1.7 percent, staying below the Fed's 2 percent inflation target.
In Quincy, Mass., Rosengren argued that the risks of QE3 are considerably smaller and more manageable than doing nothing. The Fed is taking "appropriate and forceful action to help the U.S. avoid a prolonged economic stagnation," he said.
The president of the Cleveland Federal Reserve Bank, Sandra Pianalto, completing the barrage of Fed officials speaking on Thursday, said the central bank would head off any threat of inflation that emerges from its actions and would keep a "sharp eye" on price pressures to make sure they stay tame.
