© Stocksak. FILE PHOTO – Federal Reserve Chairman Jerome Powell (C), speaks with Chicago Fed President Charles Evans and St Louis Fed President James Bullard during a conference about monetary policy at Federal Reserve Bank of Chicago in Chicago (IL, U.S.A., June
By Howard Schneider
WASHINGTON (Stocksak), – Charles Evans & James Bullard are the longest-serving monetary policymakers at the U.S Federal Reserve. They are a pair of PhD economists who have been at the heart of central bank debates through two severe crises and often approached it from very different perspectives.
Evans, the Chicago Fed president, refers to himself as a “hopeless romantic”. While Evans regards the Phillips Curve, an economic concept that has been used for decades to guide policymaking with its tradeoff between unemployment (inflation) and unemployment (with its tradeoff between the two), Bullard, the St. Louis Fed head, doesn’t like the idea. He puts more emphasis on psychology, expectations, and has played with different theories about what’s behind the price levels.
They’ve settled on roughly the same spot to serve as an initial stopping point, at least if the economy performs according to expectations. This is where they feel will lower inflation and where they’d be willing keep policy in place to prevent any inflation surprises.
Many Fed officials are in the same place. As September came to an end, 18 of 19 Fed policymakers had seen the policy rate at 2023’s end range just a quarter of a percentage point above or below their median of 4.6%. This is approximately the midpoint of a range between 4.5% and 4.75%. The Fed’s current rate of policy is 1.5 points lower at 3.00%-3.25%. This follows a hectic half year of rate hikes from near zero back March to try to curb the highest inflation in forty years.
Evans and Bullard gave separate interviews to provide a glimpse into the mechanics behind Fed policymaking.
Graphic: Fed rate projections – https://graphics.reuters.com/USA-FED/RATES/lbpggrgwbpq/chart.png
EVANS: “REAL RATE” OF 2%, WITH SOME HELP
Evans recently stated that his figure was calculated by estimating the “real” or inflation-adjusted federal fund rate. This could lower inflation while not causing a drastic rise in unemployment. He stated that a real rate of 2% was “in line” with past restrictive Fed policies and suggested the possibility of a “soft” landing.
A gap between the fed funds rates and inflation of 2 percentage points would be less than in previous tightening cycles. It remained at around 3 percentage points in the years preceding the 2007-2009 recession. The goal is to lower the inflation rate without causing a significant rise in joblessness.
Evans stated that he considers how inflation will evolve under the appropriate policy in order to hit a moving target. Evans believes that the “core” price index for personal consumption expenditures should be stripped of volatile food and energy to provide a better understanding of the underlying trends. It should end 2023 at 3.1%.
Evans said that in addition the Fed funds rate Evans also accounts for tightening financial conditions due to the Fed’s drawdown and adds “a little more for financial volatilty just in general around world” – accommodations Fed officials acknowledge in theory but Evans recently put a number on.
He said that combining “quantitative tightening”, and the impact of global volatile, is equivalent to about half a point on the federal funds rates.
The bottom line: A target of 2% for the “real rate” and 3.1% inflation next fiscal year would imply that the Fed must raise rates to 5.1%. The figure is reduced to 4.6% when you account for the impact of other forces.
Graphic: Federal Funds rate and inflatio – https://graphics.reuters.com/USA-FED/RATES/gkplwmwdevb/chart.png
BULLARD: A “GENEROUS TAYLOR” RULE
John Taylor, an economics professor at Stanford University, developed the Taylor Rule in the early 1990s. It has since been a guideline for central bankers. It involves the difficult estimation of the underlying “neutral rate of interest” – the rate that is neither restrictive or accommodative to growth. Also, the gap between current and potential economic output. The basic formula relies on the distance between inflation and a central bank’s price target to recommend an appropriate policy rate.
There are many variations of each type, with different levels of complexity. Bullard has one that he refers to as “generous” because it requires less harsh adjustment of interest rate than a more traditional Taylor rule would. Some versions suggest a federal funds rates near 8%. Others are “minimalist” in reducing the complexity and number of adjustments.
He uses an inflation calculation by the Dallas Fed, which relies on a “trimmed means,” which tosses out the fastest and slowest moving prices rather that automatically removing food and energy from the most volatile. As of August, the price index was rising at 4.7% annually, which is slightly lower than the 4.9% annual rate of the “core personal consumption expenditures index.
Bullard stated that he updated his calculations recently, which he had presented earlier in the year, when inflation was lower. “You make the most generous assumptions, and you get to four-and a-half or 4.75” on the federal funds rates.
He said that if the target rate has to rise, it will be because inflation isn’t falling the way we hope.