10‎ > ‎s‎ > ‎


12:24 pm ET
Oct 5, 2010

Business Cycles

Q&A: Chicago Fed’s Evans Elaborates on His Call for Aggressive Fed Action

  • Article
  • Comments (26)
  • By
  • Jon Hilsenrath
    • Jon.Hilsenrath@wsj.com
    • Biography
      • Jon.Hilsenrath@wsj.com
      • Biography

    Charles Evans, president of the Federal Reserve Bank of Chicago, is calling for strong action by the Fed to charge up the economy, including a new program of U.S. Treasury bond purchases and possibly an audacious public declaration by the central bank that it wants inflation to rise for a time beyond its informal 2% target.

    The following is an edited transcript of an interview he did with The Wall Street Journal’s Jon Hilsenrath. (Read the related article.)

    Bloomberg News
    Chicago Fed President Charles Evans

    How has your forecast changed in the past few months?

    Evans: My forecast has certainly moderated a bit in the last few months. We’re looking for growth later this year to be 2% to 2.5% and next year somewhere around 3%, maybe 3.5%. Then it picks up after that. What everybody has been disappointed about is the eventual return to growth above potential output continues to be pushed out further into the horizon. With growth like that we’re not going to see much improvement in the labor market at all. This could be consistent with continued positive employment growth but really not enough to lead to noticeable improvement in the unemployment rate, which is 9.6%. In the last several months I’ve stared at our unemployment forecast and come to the conclusion that it is just not coming down nearly as quickly as it should at this point in the recovery. Correspondingly the inflation data have been under-running what I would say is price stability. We put out a forecast for inflation five or six years out. For me price stability is 2%. If I look at a forecast for 2012 core PCE inflation, it is not unreasonable for that to be 1%, and that is low compared to 2%. The unemployment rate is very high. Inflation is low. To me that means we need an accommodative stance of monetary policy.

    It’s not accommodative enough?

    Evans: We need more accommodation. A lot of people respond that their take on monetary policy depends on the data coming in from here on out. For me, the data have spoken very clearly. As I stared at the forecast even before the August FOMC meeting, I had come to the conclusion that things were very different than what I had been expecting in previous meetings. This is a far grimmer forecast than we ought to have. So yes, I’m in favor of more accommodation.

    Looking out to 2013 do you see the same kind of story?

    Evans: It is not unreasonable to expect inflation in 2012 of 1%. In 2013, it is going to be less than 1.5% unless something very different were to occur. My forecast is premised on the idea that inflation expectations are relatively well maintained. There continues to be a large resource gap that is going to hold down pricing pressure for firms. And that will hold down inflation. That would continue for quite some time under that forecast. The unemployment rate would come down only slowly.

    Gold prices and commodity prices have risen quite a lot. Does that register?

    Evans: I don’t put a lot of weight on those indicators. Gold moves up and moves down. Commodity prices are often driven by stronger demand around the world and with emerging markets doing better at this point in the cycle that is part of it. Does it worry me about inflationary expectations? I just don’t see that at the moment. When I talk to people in the business community there is not a lot of pricing power.

    There has been a lot of focus on divisions within the Federal Open Market Committee. Is that an impediment to action?

    Evans: We’re at a very difficult point in the economic cycle. We’ve just come out of a very deep recession. We’re experiencing a recovery. Don’t misread what I’m saying. The recovery continues. It’s moderate. I’m really not looking for a double dip. But this is a time that challenges your thinking on how economies work and the theories underlying them. The unemployment rate is very high. Is it high because of weak aggregate demand? That is my viewpoint. Is it high because there is a lot of job mismatch and the natural rate is higher? Some of that but not nearly as much as others have indicated. But there is a wide scope for disagreement, and that does make any discussion among a large number of people challenging. But I’m confident that the committee will talk this through robustly and come to good decisions.

    Where is the common ground on the committee right now?

    Evans: The statement is fairly clear on that. We see the economy is recovering. We see inflationary pressures lower and we see the unemployment rate high and it is going to be slower to come down. With the funds rate already at zero, there is a pretty valid question as to how accommodative is monetary policy. Some people would point to the size of our balance sheet and say there is an enormous amount of accommodation. Just look at the amount of excess reserves in the system. Milton Friedman looked at the U.S. economy in the 1930s and he saw low interest rates as inadequate accommodation, that there should have been more money creation at that time to support the economy. That wasn’t based upon the narrowest measure of money, like the monetary base or our balance sheet. It was based on broader measures like M1 and M2 and how weak those measures were. I’ve come to the conclusion that conditions continue to be restrictive even though we have a lot of so called accommodation in place. An improvement would be a dramatic increase in bank lending. That would be associated with broader monetary aggregate increases. Then we would begin to see more growth and more inflationary pressures and then that would be a time to be responding.

    How do you assess the costs and benefits of additional quantitative easing?

    Evans: The forecast is not commensurate with what I take our dual mandate responsibilities to be. The unemployment rate is too high; inflation is lower than what I think price stability is. I would clearly favor more accommodation. If we were to do more large scale asset purchases, namely Treasurys, that would have a beneficial effect. There would be some reduction in long-term yields. That would be of some help. But given the nature of the outlook, much more accommodation than that is probably what’s called for. We have to think a little more carefully about the potential tools that we have available to us.

    The other tool to look at is communication.

    Evans: That’s largely right. The question is how to implement those communication strategies.

    What’s on your mind on that front? Does the Fed need to make a more clear commitment to have a higher inflation rate?

    Evans: It is a very challenging topic for a central banker. We all know that price stability is fundamentally important for a vibrant economy. We had Paul Volcker here last week at a conference. There is nobody who would want, in any way, to lose what Paul Volcker won for the American people by fighting inflation and achieving price stability, and the Greenspan Fed. But the current circumstances are really extraordinary. It seems to me if we could somehow get lower real interest rates so that the amount of excess savings that is taking place relative to investment needs is lowered, that would be one channel for stimulating the economy. That could be done through communication. I take our price stability mandate to be 2% inflation. We’re not at 2%. I foresee 2012 inflation as 1%. If we could indicate to the public that we want inflation to increase toward that price stability goal, that would serve to lower real interest rates given that short-term nominal interest rates are close to zero. Thinking about the fact that we’re running below our inflation objective and what it might mean to make up some part of that somewhere along the line, that would also give rise to lower real interest rates. Convincing the public that this is what we intend to do, that could be a useful tool.

    New York Fed President William Dudley talked about making up lost ground on inflation later. You support that?

    Evans: That is a potentially useful policy tool at this point and I definitely think we should study that more. That comes out of the literature.

    Core inflation has been around 1.5% for the last few months. Why is it an issue now?

    Evans: It’s been trending down for a while. When you superimpose on that the resource slack in the economy, the high unemployment rate the output gap, that’s what leads me to think that a forecast of 1% in 2012 is not unreasonable. From here on out, as you think about how the economy is likely to recover if inflation falls and nominal interest rates are as low as they can go, that’s not helpful.

    Real rates are already negative. Some people argue that negative real rates could cause another asset price bubble or a commodity price bubble, which could hurt the U.S. economy for instance if oil prices rise lot. Does that give you pause, the risk that negative real rates could stimulate parts of the economy or financial system that you’re not looking to stimulate?

    Evans: I think we’re in a liquidity trap where there is excess savings, greater than investment. It would take a lower real interest rates to address that. Lower real rates would be helpful. I’m not as concerned about the risk that you’re pointing out because of that. When it comes to commodity prices, global conditions are unbelievably important for how high some commodity prices are right now. There is not that much that changes in U.S. policy will influence that, within a range. That doesn’t worry me quite so much, though we’re mindful of it. On the financial risk side, I’m well aware of criticisms that previous periods of lower interest rates could have played a role in previous financial exuberance. I don’t agree with that per se. But it is the case that I think you need to use macro prudential regulation to keep an eye on risks within the financial system. But, look, if the right thing to do for the macro economy is to have lower interest rates but that comes with some risk for the financial system, we’ve only got one monetary policy tool and we have to focus on our mandate. But we have other supervisory tools which are supposed to  address emerging risks in financial markets. I think they have to be used.

    Is quantitative easing by itself enough without a different communication strategy by the Fed?

    Evans: I think that additional asset purchases would have an effect. I think it would be beneficial. I worry that that alone would not be enough to address the particular view that I have.

    What is your view of the James Bullard (St. Louis Fed president) approach to asset purchases, the idea of some kind of state contingent asset purchase program, as opposed to some kind of shock and awe type program?

    Evans: I’m favorably disposed toward the approach that Jim has mentioned… I just think that far more accommodation is required.

    It sounds like your thinking has evolved quite a bit in the past few months. What brought you to this strong view?

    Evans: Short term interest rates are at zero. That’s a classic tell for a liquidity trap. People are saving tremendously. Businesses are sitting on a pile of cash. They’re doing what they need to do to make good profits, but through cost cutting and not by growing the top line. There is a lot of caution and risk aversion. Households feel that. The employment risks that they face, that limits spending, so saving is high. That is a classic tell for a liquidity trap as well. Staring at our forecast, I knew this when we first put out those projections. I knew it was going to be bad. And it is not improving. We’re pushing out the growth prospects. I just think it calls for much more than we’ve put in place. My view on accommodation at the moment is not data dependent. I think we’re there.

    What mistakes did the Japanese make in dealing with their liquidity trap that you as a policy maker want to avoid?

    Evans: We’re staring at a pretty grim outlook and others have done that in the past and I don’t think we should wait until 2012 to find confirmation that things are going to continue along this path. I just think additional action would be helpful.



    Follow @WSJecon for economic news and analysis
    Follow @WSJCentralBanks for central banking news and analysis

    Get WSJ economic analysis delivered to your inbox:

    Sign up for the Real Time Economics daily summary


    Subpages (1): 2