WASHINGTON (MarketWatch) — Ahead of next week’s Federal Reserve meeting, one former official agrees with many of the committee that it’s time to change the central bank’s guidance on how long it will keep short-term interest rates near zero.
But to what is the question.
Randall Kroszner, a former governor of the Federal Reserve between 2006 and 2009 and now a professor at the University of Chicago Booth School of Business, talked to MarketWatch about how the central bank can thread the needle between both a qualitative and a quantitative approach to setting guidance, as well as his outlook on the economy — and the Chicago Cubs.
MarketWatch : The Federal Reserve policy committee is meeting next week. Will they continue to taper?
Kroszner : I don’t think there has been any new evidence that has come to the Fed to change the decision to continue the reduction of asset purchases.
MarketWatch : What would it take for them to change?
Kroszner : It would take quite a bit for them to change the so-called taper. They’d have to have a significant change in their perception of the risks in both the U.S. and global economy, a significant change in labor market performance, or a significant change in inflation.
MarketWatch : Why does the Fed insist that taper is not on a “pre-set course?”
Kroszner : They have started to think that some of the costs may potentially be outweighing the benefits or asset purchases. And since at least the [economic] data so far are coming in broadly within their forecasted range, there is really not much of a reason to change the policy that they have set on which is to have this gradual step-down.
MarketWatch : How to you see the economy. You’re optimistic that we could see growth in 2014 around 3%?
Kroszner : There is a reasonable chance of achieving higher growth than we’ve seen over the last few years. But we still have a lot of headwinds. We seem to have put some of the fiscal uncertainty behind us, which I think has been a very important drag. We still have a lot of uncertainty on the regulatory front, particularly health care affecting the willingness of firms to hire, and then, of course, there are global uncertainties. The U.S. fundamentals would likely get us to 3% growth for this year, but there are still a lot of things that could go wrong to challenge that.
MarketWatch : What is your outlook for housing?
Kroszner : The Fed has been able to thread the needle and pursue the policy that it wishes to, which is to reduce the pace of asset purchases, without it having significant negative repercussions on the housing recovery.
MarketWatch : What is your outlook for inflation?
Kroszner : In the short and intermediate run, it is very hard to see where the inflation pressures would come from. It is possible that with a more robust labor market recovery we will start to see some growth in wages, and, actually, that would broadly be welcome. But given the slow pace of the recovery and given that it looks like much of the rest of the world is not recovering very rapidly, you are not going to be getting a lot of external pressures on inflation. And so, it is likely that inflation will continue to stay low for the intermediate term.
MarketWatch : Given this outlook, what will the Fed do at the meeting? Do you see a change in the forward guidance?
Kroszner : I think the substance of the policy is unlikely to change because the data have really has been consistent with their forecasts and where they were a few months ago. However, it is time to seriously re-think that 6.5% unemployment target because we are so close to it.
MarketWatch : How will they change it?
Kroszner : A move from 6.5% to something that might be more qualitative would be perceived by the market as not a substantive change in policy even though it is a substantive change in the words.
One way to think about it is to look at the evolution of the forward guidance over the last five years. So five years ago, when I was there, we introduced the idea of keeping extraordinary accommodation for an extended period. Then there was a move to an explicit date and then a move to 6.5% as a guideline.
Those other transitions were smooth because the Fed had gotten market expectations to be roughly where they wanted them to be, and then they could move on to a different way of expressing it, and that is likely to be what will happen now.
MarketWatch : So what will it look like, something like the Bank of England’s 18 different measures of labor market health?
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| Randall Kroszner, ex-governor of the U.S. Federal Reserve, in 2012. |
Kroszner : What came through loud and clear in the market’s response to the Bank of England’s approach is that was not helpful. There is an optimal amount of transparency. When you start going with too much detail then that transparency becomes opacity. It is more likely the Fed will be more qualitative about the state of the labor market, with some particular indicators mentioned but perhaps not as much focus on the unemployment rate in and of itself. Given market expectations being so well grounded from the forward guidance from before, they can make that transition reasonably smoothly.
MarketWatch : So the Fed can move because they’ve earned the market’s trust?
Kroszner : Moving away from 6.5% unemployment is not going to change the way the market thinks. They are going to realize that this is not an attempt by the Fed to change market expectations or a fundamental change in the way they are looking at things. It is just given that the unemployment rate has fallen by so much, and mostly for not the best reasons, that they will use different words but really convey the same substance about how they are thinking about the economy and what they are likely to do.
MarketWatch : When do you think the first rate hike will come?
Kroszner : I do think it will come sometime in my lifetime.
It really is based on the economics, the data, and the forecast. If the economy grows roughly in line with their forecast, then you could start to see a move towards to some interest rate increases in late 2015, but obviously things could change. There could be other shocks. It is possible if the economy takes off more rapidly, and the labor market starts to recover more rapidly, we could start to see a move up in inflation and then I think the Fed would be forced to act a bit earlier. Models always have smooth transitions. In the real world we never get that smoothness. So I am sure that something will happen that will be inconsistent with the forecast to either make the Fed move a little bit faster or a little bit slower.
MarketWatch : So which will happen first? The Cubs win the World Series or short-term interest rates get to 4%?
Kroszner : I think that’s a close call.
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