Fed official eyes change in policy signals

Plosser says forward guidance policy now 'too passive'.

Employment and inflation in the US are likely closing in on the Federal Reserve's goals faster than expected, which may soon force the central bank to alter its policy signals, a top Fed official said Tuesday.

In a speech before the Economic Club of New York, Federal Reserve Bank of Philadelphia President Charles Plosser expressed concerns about the way the Fed is currently guiding the public about the future path of the policy rate, calling the so-called forward guidance "too passive."

"I believe that we are closing in on our goals -- perhaps faster than some people might think. So, while I supported the recent policy statement, I have growing concerns that we may have to adjust our communications in the not-too-distant future," Mr Plosser said in prepared remarks. "Specifically, I believe the forward guidance in the statement may be too passive, given underlying economic conditions."

The Fed's policy-setting board delivered its most recent statement on June 18. In it, the board again displayed willingness to hold rates near zero to support the US economy, citing a slow-to-recover housing market and subdued inflation. Fed Chairwoman Janet Yellen, in a post-meeting press conference, called the recent uptrend in inflation data "noisy."

Mr. Plosser, long an outspoken hawk about inflation, said Tuesday he is "fairly optimistic" about the economy, which supports remarks he made in May that a rate rise may come sooner than many market participants are anticipating.

The official, who holds a voting slot on the policy board this year, says he sees the unemployment rate falling to 5.8 per cent by the end of this year and 5.6 per cent by the end of the 2015, while expecting inflation to stabilise around 2 per cent next year. The latest payrolls report, in May, showed the jobless rate at 6.3 per cent.

Beyond his views on the economy, Mr. Plosser spent the majority of his speech Tuesday making a case for why the Fed should take a more formulaic approach to setting policy. "Because systematic policy is easily communicated to the public, it also greatly improves the transparency and predictability of monetary policy, which reduces surprises," he said.

"Businesses and consumers are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances even if they are not certain what those economic conditions might be."

Basing the policy rate's future path on a rule also enhances accountability, and in the long run leads to more economic stability, he argued. As an exercise, Mr Plosser cited five rule-based models, including the well-known Taylor Rule and variations of that rule since its 1993 introduction, among others.

Plugging in the midpoints of the Fed board's latest economic projections, Mr Plosser says that while each of the five rules lay out a different path for the policy rate, every one indicates an increase should occur next quarter. "These rules therefore indicate that lift-off should come sooner than many seem to be expecting, based on our current policy guidance," he warned. Setting a policy rate based on rules can also help to explain uncertainty, Mr Plosser said.

By plugging in a range of different economic assumptions, the formulas can spit out a range out appropriate policy rates. That range is a way of communicating to the public how policy will vary based on how the economy evolves.

"Rather than trying to shoot for particular future values, a monetary policy report under a rules-based approach could convey the uncertainty and still assure that decisions will be driven by the state of the economy," he said.

Mr Plosser acknowledged that deriving a policy rate from a hard model may not always work, citing extraordinary times such as September 11 and the collapse of Lehman Brothers. But even then, the official says rule-based models become useful benchmarks, helping the Fed to explain why policy needs to be more or less accommodative than what the economic state might suggest.

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