Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the U.S. central bank should develop and make public a contingency plan that would explain how it would react to developments in the economy.
Such a contingency plan by the policy-setting Federal Open Market Committee would “provide clear guidance on how it will respond to a variety of relevant scenarios,” Kocherlakota said today in prepared remarks for a speech in Sioux Falls, South Dakota.
Kocherlakota said a contingency plan would reduce uncertainty about the Fed’s actions among consumers and companies, which he said has reduced incentives to spend and hire. It would also enhance the central bank’s credibility and transparency, he said.
His comments extend a discussion among members of the FOMC about how to better explain their forecasts and policies to the public. At a press conference last week, Fed Chairman Ben S. Bernanke said options include clarifying the central bank’s long-term inflation goal, publishing the likely path of interest rates, and tying the Fed’s pledge to hold rates low to specific levels of employment and inflation -- a strategy espoused by Chicago Fed President Charles Evans.
The Fed reached no decision to adopt a new communication strategy at its Nov. 1-2 meeting and didn’t decide on any additional programs to combat an unemployment rate that has stayed near 9 percent or higher for 31 months.
Kocherlakota supported this month’s policy statement, after joining Dallas Fed President Richard Fisher and Philadelphia’s Charles Plosser in dissenting from the previous two statements announcing new stimulus measures.
Kocherlakota said the central bank has “tools remaining” to lower borrowing costs. It could buy more Treasury securities or housing debt, as well as “extend its prediction for how long it will keep its target short-term interest rate exceptionally low,” he said.
“However, the FOMC should do more than simply decide at each meeting whether or not to buy more assets or to keep interest rates low for longer,” he said.
The Minneapolis Fed chief provided an example of the contingency planning he called on the Fed to adopt, imagining a situation where core inflation -- which excludes prices of food and energy -- rises more than expected and unemployment remains elevated.
“Suppose hypothetically that core inflation, and the outlook for core inflation, has risen to 3 percent by the end of 2013, while unemployment has fallen to between 8 percent and 8.5 percent,” he said. “A public contingency plan would allow the public to know what the committee intends to do in that eventuality.”
In their summary of economy projections, released last week, central bankers said they expect core inflation to remain between 1.5 percent and 2 percent through 2014. Policy makers forecast unemployment will fall to 8.5 percent to 8.7 percent at the end of 2012 and 7.8 percent to 8.2 percent at the end of 2013.
Employers added 80,000 workers to payrolls in October, the Labor Department reported on Nov. 4, and the unemployment rate fell to 9 percent from 9.1 percent.
Kocherlakota said the Fed’s recent decisions to pledge to hold interest rates near zero through at least mid-2013 and to extend the maturities of $400 billion of government securities in its portfolio were inconsistent with economic data.
“This kind of inconsistency is much less likely to occur once the FOMC has formulated an explicit public contingency plan.”
“A public FOMC contingency plan can help reduce the level of policy uncertainty being created by the Fed,” Kocherlakota said.
Kocherlakota, 48, received his doctorate in economics from the University of Chicago. He taught at the University of Minnesota before becoming president of the Minneapolis Fed in October 2009.
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