A U.S. 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%. Though that would likely take four or more years, given the nation's current 8.1% 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%" 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% 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.
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%, unless inflation rises above 3%
Economists polled by Reuters last week fingered 7% 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.
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% and 2.25%, 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%, so it is unlikely that it would do so until the jobless rate falls "considerably" below its current 8.1% level.
