US Fed confronts dilemmas over monetary policy


US Fed confronts dilemmas over monetary policy

Nick Beams

7 September 2017

A speech by Lael Brainard, a member of the US Federal Reserve board of governors, to the Economic Club of New York on Tuesday pointed to the conundrums facing the central bank as it considers the next steps to take in “normalizing” monetary policy.

The Fed has two major decisions to consider at its meeting later this month: whether to continue to lift its base interest rate, and when to begin to reduce its assets holdings of $4.5 trillion. These assets have accumulated as a result of corporate and treasury bond purchases under the quantitative easing program initiated after the 2008 financial crisis.

Despite the massive injections of money into global financial markets by the Fed and other central banks, almost a decade on there is no sign of the US and global economy returning to anything resembling pre-crisis conditions and relationships.

The Fed is confronted by two contradictory sets of data. On the one hand, the fall in the official unemployment rate in the US to below 5 percent would indicate further rises in the base interest rate if historical precedents are to be followed.

However, the persistence of low levels of inflation, well below the Fed’s target rate of 2 percent, and evidence that prices are falling, points to deciding to keep the base rate at its present historically low level.

The combination of low official unemployment levels coupled with low, and even falling inflation, contradicts the predictions of the so-called Philipps curve, on which the Fed has based its policies in the past. According to this model, as unemployment falls, the inflation rate should start to rise as workers seek and obtain higher wages. But this is not taking place.

Brainard began her speech…

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