Federal Reserve governor Lael Brainard painted a mostly positive picture of the near-term outlook for the US economy while advocating longer-term changes in the conduct of monetary policy in an era of low interest rates and subdued inflation.
“There are good reasons to expect the economy to grow at a pace modestly above potential over the next year or so, supported by strong consumers and a healthy job market, despite persistent uncertainty about trade conflict and disappointing foreign growth,” Brainard said in a speech to the New York Association for Business Economics.
While downside risks remain, Brainard said the Fed has taken “significant action” in response by lowering interest rates three times this year, noting that it will take some time for the cuts to take their full effect.
“I will be watching the data carefully for signs of a material change to the outlook that could prompt me to reassess the appropriate path of policy,” Brainard said, in a signal that she’s comfortable with leaving policy on hold for the time being.
Brainard spent much of her speech discussing her prescriptions for longer-term concerns confronting the central bank, which are the subject of an ongoing policy-framework review.
In its quest to bring inflation back to the Fed’s 2% target — it has missed to the low side for most of the past seven years — Brainard recommended pursuing a policy she called “flexible inflation averaging.”
“It may be helpful to specify that policy aims to achieve inflation outcomes that average 2% over time or over the cycle,” she said. “Given the persistent shortfall of inflation from its target over recent years, this would imply supporting inflation a bit above 2% for some time to compensate for the period of under-performance.”
She differentiated this from more “rigid” forms of so-called inflation make-up strategies that may be difficult for policy makers to communicate to financial markets and the public.
Brainard also offered a separate policy option to help the Fed stimulate the economy if it is again forced to cut overnight rates to zero in a recession. In such a case, the Fed should use asset purchases to cap interest rates on short-to-medium range Treasury securities.
“The yield curve ceilings would transmit additional accommodation through the longer rates that are relevant for households and businesses in a manner that is more continuous than quantitative asset purchases,” she said.
“The combination of a commitment to condition liftoff on the sustained achievement of our employment has the potential to work well,” she said.