Fed's Williams : Declining Neutral Rates a Major Challenge for Central Banks
By Michael S. Derby
A shift in interest rates toward persistently lower levels means central banks may need to look at new strategies to help keep inflation at desired levels, John Williams, the president of the Federal Reserve Bank of New York, said in the text of a speech to be delivered Friday.
"The global decline in the neutral rate of interest over the past quarter century poses significant challenges to maintaining well-anchored inflation expectations in a standard inflation-targeting regime," Mr. Williams said in the text of a speech to be delivered at a conference at his bank. In this environment, the problem central banks will need to solve "is the risk of inflation that is persistently too low, rather than too high."
Mr. Williams did not comment on monetary policy or the economic outlook in his prepared remarks, which come a day after the Fed released meeting minutes from its most recent gathering. That document pointed to a good chance the Fed will raise rates next month, although what happens after that has grown less certain. Mr. Williams will meet with reporters next Tuesday at a briefing at his bank, where he may weigh in on what he thinks the ideal path for monetary policy should be.
Mr. William's remarks Friday noted that the decline in the level of interest rates that's neutral in its impact on the economy owes to demographic shifts, slower productivity rates and increased interest in the financial sector in holding safe assets.
The problem for central banks is that lower neutral rates mean monetary-policy interest rates will be lower than they were in the past and nearer to zero, giving the central bank less room to lower them in times of trouble. Mr. Williams warned there's a real risk that inflation shortfalls could lead to declining inflation expectations, which will then further depress price pressures.
One way to address the situation, Mr. Williams said, is to do what has been done in recent years. And that's to continue to have an inflation target and address changes in the economy with the appropriate range of short-term rate changes and unconventional policies.
Alternatively, central banks could commit to allowing inflation to run higher than they would otherwise want in good times, as a way of offsetting the times when inflation falls short of target, he said.
Mr. Williams also plugged price-level or nominal GDP targeting systems, which offer a target path for either prices or GDP and commit to achieving it. If there's a shortfall from the target, it's made up for by overshooting the target, for example.
"Both average-inflation and price-level targeting can solve the problem of anchoring inflation expectations at the target rate while maintaining a low inflation target rate amid low neutral rates," Mr. Williams said. "Although price-level targeting is a bigger leap from inflation targeting than average-inflation targeting, each can be implemented in ways that are very similar to standard inflation targeting, either in terms of forecast-targeting or a policy rule," he said.
Mr. Williams didn't endorse any of the strategies, but he has spoken favorably of price-level targeting in past remarks. There's growing interest in the Fed to review fundamental aspects of how monetary policy is made, and some central bankers have even called for their to be a regular process where the Fed can take stock of how it does business.