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Bernanke proposes an approach to policy that is elegant and straightforward to communicate. I will focus on those elements that I find particularly relevant for the challenges faced by policymakers and suggest some implications and complications.
My comments are not intended to address current policy. In this environment, frequent or extended periods of low inflation run the risk of pulling down private-sector inflation expectations, which could amplify the degree and persistence of shortfalls of inflation, thereby making future lower bound episodes even more challenging in terms of output and employment losses.
To the extent it is weighing on longer-run inflation expectations, the persistently low level of the neutral federal funds rate may be a factor contributing to the persistent shortfall of U.
For instance, inflation has remained stubbornly below the FOMC's 2 percent target for the past five years even as unemployment has fallen from 8. Reflecting on the Fed's available "policy toolbox," Bernanke concludes that the available tools are not likely to be sufficient and proposes a framework that relies on forward guidance with commitment to help central banks achieve their inflation and employment objectives.
The Makeup Principle The academic literature on monetary policy suggests a variety of prescriptions for preventing a lower neutral rate of interest from eroding longer-run inflation expectations. The paper argues convincingly that many of these proposals present practical difficulties that would create a very high bar for their adoption.
For instance, raising the inflation target sufficiently to provide meaningfully greater policy space could engender public discomfort or, at the other extreme, risk unmooring inflation expectations. The transition to a notably higher target is likely to be challenging and could heighten uncertainty.
As I have noted previously, the persistence of the shortfall in inflation from our objective is an important consideration for monetary policy. For example, while price-level targeting would be helpful in the aftermath of a recession that puts the economy at the effective lower bound, it could require tightening into a negative supply shock, which is a very unattractive feature, as Bernanke points out.
Bernanke's proposal thus has the advantage of maintaining standard practice in normal times while proposing a makeup policy in periods when the policy rate is limited by the lower bound and inflation is below target.
His proposed temporary price-level target would delay the liftoff of the policy rate from the lower bound until the average inflation over the entire lower bound episode has reached 2 percent and full employment is achieved. This type of policy, which would result in temporary overshooting of the inflation target in order to make up for the previous period of undershooting, is designed to, in Bernanke's words, "calibrate the vigor of the policy response Following deep recessions of the type we experienced inthere appears to be an important premium on "normalization.
Moreover, the benchmark for "normal" tends to be defined in terms of pre-crisis standards that involved policy settings well away from the lower bound, at least initially, because it may take some time to learn about important changes in underlying financial and economic relationships.
For example, the factors underlying what we now understand to be the new normal of persistently low interest rates were in many cases initially viewed as temporary headwinds. In these circumstances, a standard policy framework calibrated around the pre-crisis or "old" normal may be biased to underachieving the inflation target in a low neutral rate environment.
The kind of policy framework that Bernanke proposes, which pre-commits to implementing the makeup principle based on the actual observed performance of inflation during a lower bound episode, could guard against premature liftoff and help prevent the erosion of longer-term inflation expectations.
Monetary policymakers operate in an environment of considerable uncertainty and therefore have to weigh the risks of tightening too little or too late against those of tightening too much or too soon.
While past experience has conditioned U. In weighing these risks, the standard approach is typically designed to achieve "convergence from below," in which inflation gradually rises to its target.
Given the lags in the effects of monetary policy, convergence from below would necessitate raising interest rates preemptively, well in advance of inflation reaching its target.
Moreover, particularly in the early stage of a recovery, this kind of preemptive approach tends of necessity to rely on economic relationships derived from pre-crisis observations, when policy rates were comfortably above the lower bound.
During a period when the policy rate is limited by the lower bound, Bernanke's proposal would represent a substantial departure from the standard approach. While a standard policy framework would tend to prescribe that tightening should start preemptively, well before inflation reaches target, Bernanke's temporary price-level target proposal would imply maintaining the policy rate at the lower bound well past the point at which inflation has risen above target.
In principle, policymakers would have to be willing to accept elevated rates of above-target inflation for a period following a lengthy period of undershooting. Just as policymakers could run a risk of low inflation becoming entrenched in the standard preemptive framework, so, too, there are risks in the temporary price-level target framework.
One risk is that the public, seeing elevated rates of inflation, may start to doubt that the central bank is still serious about its inflation target. It is worth noting that the policy is motivated by the opposite concern--that convergence from below, following an extended lower bound episode, may lead to an unanchoring of inflation expectations to the downside.
Still, a conscious policy of overshooting may be difficult to calibrate, especially since the large confidence intervals around inflation forecasts suggest that the risks of an undesired overshooting are nontrivial.
A related risk is that the central bank would lose its nerve: Maintaining the interest rate at zero in the face of a strong economy and inflation notably above its target would place a central bank in uncomfortable territory.
One additional challenge of the proposed framework is specifying a path for the policy rate immediately following liftoff that smoothly and gradually eases inflation back down to target and facilitates a gradual adjustment of the labor market. In the proposed framework, once the cumulative average rate of inflation during the lower-bound period has reached the target of 2 percent, policy would revert to a standard policy rule.
Even with a smoothing inertial property, a standard policy rule could result in a relatively sharp path of tightening, and the anticipation of the steep post-liftoff rate path itself could undo some of the benefits associated with the framework.
Thus, there would likely need to be a transitional framework to guide policy initially post-liftoff that might make both communications and policy somewhat more complicated.
Integrating the Policy Rate and the Balance Sheet The temporary price-level targeting framework proposed by Bernanke is appealing on a conceptual level because it proposes a simple and clear mechanism to help policymakers deal with the challenges posed by the lower bound on the policy rate in an environment of uncertainty.
The reality is more complicated, however, especially if, as the paper suggests, many central banks in advanced economies are likely to operate with an additional tool when the policy rate is constrained. In the paper, Bernanke cites Chair Yellen's Jackson Hole speech, which suggests that in a recession, the FOMC could be expected to turn to large-scale asset purchases as well as forward guidance after the federal funds rate is lowered to zero.
In the United States, from the time tapering was first discussed to the September meeting, when the path for balance sheet runoff was adopted, FOMC minutes and statements suggest that participants considered the degree of accommodation provided by both policy tools in their discussions of the sequencing and timing of changes to policy settings.
Discussions about the sequencing of "normalization" and the delay of balance sheet runoff "until normalization of the level of the federal funds rate is well under way" effectively consider the extent to which maintaining the balance sheet may continue to provide makeup support for the economy while enabling the policy rate to escape the lower bound earlier than otherwise in a low neutral rate environment.October IMF Policy Paper IMF POLICY PAPER GLOBAL IMPACT AND CHALLENGES OF UNCONVENTIONAL MONETARY POLICIES IMF staff regularly produces papers proposing new IMF policies, exploring options for reform, or.
Monetary Policy Paper "Monetary Policy is the most significant function of the Fed; it is probably the most-used policy in macroeconomics" (Colander, , p. ).
This paper will discuss and elaborate on "The Monetary Policy Report" submitted to the Congress on February 11, and concepts of Macroeconomics by David Colander. To answer those questions, the Hutchins Center on Fiscal & Monetary Policy has commissioned two papers that are forthcoming in the Journal of Economic arteensevilla.com Date: Oct 17, transmission of shocks to monetary policy uncertainty is the focus of this paper.
Recently, there has been a surge of interest in economic policy uncertainty. 1 Baker, Bloom, and Davis () develop an index of overall economic policy uncertainty (EPU), including ﬁscal. Monetary Policy Monetary policy is the mechanism of a country’s monetary authority (usually the central bank) controlling money in the economy so as to promote economic growth and stability by creating relatively stable prices and low unemployment.
Monetary policy always has a short-term and a near-term objective. In the best of economic times, they're one in the same: Maintain steady growth in output, low inflation and full employment.