The US Federal Reserve should consider a more aggressive round of quantitative monetary easing in order to avoid "Japan-style deflation” for the US economy, Randall Kroszner, a former board member of the Federal Reserve, told Euromoney, ahead of next week’s meeting of US central bankers. He also called for the Fed to publicly communicate the economic conditions in which it will loosen monetary policy further in order to arrest sagging market confidence. “The key aspect that animates [central bank policymakers] is the specter of deflation and that through monetary policy we can avoid a Japan-like deflation outcome,” Kroszner, a professor at the University of Chicago Booth School of Business, said.
Figures released on Friday showed US growth slowed for the second consecutive quarter at 1.5% driven by consumer deleveraging. Friday’s figures highlight “growth was lower over the past few years” than has been previously estimated and “remains below potential”, he said. Meanwhile, the US consumer price index at 1.7% is below the Fed’s long-run 2% target while employment at 8.2% is higher than the Fed’s unofficial target of 5.5%.
These figures “provide a foundation for action”, such as a further round of quantitative easing, including purchases of mortgage-backed securities. Even though “the effectiveness of such a policy has diminished over time...the policy has been successful in reducing mortgage borrowing costs”, he said.
In recent weeks, several FOMC (Federal Open Market Committee) members have publically discussed new monetary policy measures. Federal Reserve Bank of San Francisco president John Williams has said the Fed should consider open-ended bond purchases and a cut in the interest earned on US banks’ reserves. However, Kroszner threw his weight behind the recent suggestion by Charles Evans, Federal Reserve Bank of Chicago president, to complement quantitative easing with a more transparent communication strategy.
Kroszner said an “open-mouth” communication strategy could include publicly indicating the employment and inflation target that would propel the Fed into a more aggressive action. “Being much more explicit about the employment and inflation rate that would induce the Fed into action would help to reduce uncertainty and fits very well with the steps the Chairman has already taken, including the creation of an inflation target”. He said more communication would boost risk-taking, domestic confidence and business investment.
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| Randall Kroszner, former Fed governor |
He said the Fed is “open” to a policy of reducing the deposit rate on banks’ reserves, akin to ECB action, but was wary of its impact on the profitability of money market funds, which, relative to GDP, are larger in the US than in the eurozone.
However, since the Fed’s assessment of economic conditions is unlikely to have changed significantly since its last meeting and there are two upcoming benchmark data releases on US employment prospects in the coming months, the Fed might decide to take no additional measures at the July 31-August 1 meeting, he said.
Earlier this year, Stephen Roach, the non-executive chairman of Morgan Stanley Asia, told Euromoney the Fed should publicly articulate the conditions in which it will withdraw stimulus amid fears that extraordinarily loose monetary policy was fuelling global asset bubbles. “There are trade-offs in using all these tools and the Fed is aware of this,” Kroszner said.
In other comments, Kroszner, who served under Ben Bernanke between March 2006 and January 2009, sounded the alarm over the lack of bi-partisan consensus on fiscal policy amid the US election season. “Reducing loopholes and creating a more efficient tax system” could, to some extent, offset the negative-growth impact of fiscal tightening. As the eurozone crisis highlights, “US debt has to paid at some point and we should be mindful of the potential cost of not creating a credible adjustment plan on the level and structure of tax rates,” he concluded.