Mpls. Fed leader explains vote against guidance change

  • Article by: EVAN RAMSTAD , Star Tribune
  • Updated: March 21, 2014 - 8:58 PM

Kocherlakota said the policy committee should have set a specific unemployment goal for triggering a raise in interest rates.

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Narayana Kocherlakota, president of the Minneapolis Fed, on Friday explained his decision to vote against the Fed's change in the way it tells investors when to expect it will raise interest rates. 2013 file photo.

Photo: Richard Sennott, Star Tribune

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The Federal Reserve’s powerful rate-setting committee should have stuck with specific numbers and goals to help people understand when it’s likely to begin raising interest rates, the head of its Minneapolis bank said Friday.

Local Fed President Narayana Kocherlakota also said he would like the committee to say that reaching at least a 5.5 percent unemployment rate is one of those goals.

In his view, the central bank’s open-market committee took a step backward Wednesday when it decided to remove specific numeric targets in its so-called “forward guidance” statement, which is designed to help people understand interest-rate decisions.

“The new guidance fosters policy uncertainty and thereby suppresses economic activity,” Kocherlakota said in a statement released Friday to explain his vote against the change.

Kocherlakota rejoined the policy committee this year after last serving on it in 2011. Its first meeting with 2014 members earlier this week also marked the debut of new Fed Chairwoman Janet Yellen.

After the meeting, she said at a news conference that the committee wouldn’t consider raising interest rates for some time after the Fed’s bond-purchasing program completely phases out later this year.

Investors initially took Yellen’s comments to mean that rates could start rising next year. But on Thursday and Friday, big investors and economists began to settle on the view that interest rates likely won’t rise until 2016. Goldman Sachs chief economist Jan Hatzius, for instance, issued a report that began, “Rate hikes are far off.”

Since the Fed slashed interest rates to near zero in late 2008 and early 2009 to free up credit and revive the economy, stocks soared in part because they faced less competition from investments tied to interest rates. As a result, the start of a return to a normal interest rate environment is something investors have watched for closely.

Fifteen months ago, the policy committee said it wouldn’t begin to raise rates until U.S. unemployment reached 6.5 percent. But as that figure got closer — it is now 6.7 percent — broader economic conditions remained sluggish. And, in Yellen’s first big step as chairwoman, the committee dropped the numeric target for a wide range of “labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.”

Kocherlakota’s vote against that move was noteworthy partly because it was not directed at a policy action but at the way in which the Fed communicates. While dissents like his are routinely publicized, members of the committee are not obligated to discuss them publicly.

Kocherlakota said in Friday’s statement that he decided to explain his opposition because he thinks the new guidance is “intended to describe the committee’s decisions for some time to come.”

In a seven-paragraph statement, Kocherlakota said using the 6.5 percent unemployment target, along with another goal of keeping inflation below 2.5 percent, was “highly effective” for setting market expectations over the past 15 months.

He added: “The committee could have adopted language of the following form: ‘The committee anticipates keeping the fed funds rate in its current range at least until the unemployment rate has fallen below 5.5 percent, as long as the one-to-two-year-ahead outlook for [personal consumption expenditure] inflation remains below 2 ¼ percent, longer-term inflation expectations remain well-anchored, and possible risks to financial stability remain well-contained.’ ”

In speeches and writings for much of the past year, Kocherlakota has argued that the 6.5 percent unemployment target should be lowered to 5.5 percent. “He’s been on this point of view for a while,” said Marvin Goodfriend, a former Fed official who now teaches at Carnegie Mellon University in Pittsburgh.

With the vote Wednesday and explanation Friday, Kocherlakota became one of only a few Fed members to create a record of dissent in both hawkish and dovish directions.

During his 2011 stint on the open market committee, Kocherlakota in one meeting joined two other members in opposing a commitment to near-zero interest rates “at least through mid-2013.” He and the two others wanted to say “for an extended period,” a hawkish view that meant at the time that interest rates might need to rise before the middle of last year.

But as the nation’s economic recovery remained slow, Kocherlakota’s view shifted and he began to express dovish reservations about when to lift rates.

Evan Ramstad • 612-673-4241

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