The Fed said in 2012 that the fall of the unemployment rate would dictate how soon it ended its policy of holding short-term rates near zero. But the rapid decline of measured unemployment has outpaced the improvement in other economic indicators, and the Fed is looking for a new measuring stick.
Several Fed officials said on Friday in New York that the Fed had yet to settle on a new approach to providing guidance to market participants about the future timing of its actions, echoing remarks on Thursday by the Fed’s chairwoman, Janet L. Yellen.
Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, said he did not expect an agreement by the time of the Fed’s next meeting March 18 and 19. “I think forward guidance is a very difficult and subtle policy practice,” Mr. Plosser said at a conference on monetary policy sponsored by the Booth School of Business at the University of Chicago. “I suspect there will be plenty of discussion.”
The Fed is facing numerous questions about the value of its efforts.
Robert E. Rubin, the former Treasury secretary and an avowed skeptic of the Fed’s bond-buying campaign, said at the conference that he also doubted the value of forward guidance. And he said he was skeptical of the Fed’s ability to control the disruptive consequences of its eventual retreat. “If there is trouble,” he said, “it will be monetary action pushing us into a downturn rather than high inflation.”
A paper presented at the conference argued that Fed officials might be underestimating the tensions building in the financial system.
Fed officials say they are watching closely, but that they don’t see evidence their policies are causing significant problems. “At this stage broadly I don’t see concerns,” Ms. Yellen said Thursday, although she added that she did see “pockets” of concern, including underwriting standards for leveraged loans.
Ms. Yellen’s comments underscored that the Fed, in looking for new problems, has been particularly focused on the use of leverage. Reliance on borrowed money was a major reason for the severity of the recent crisis.
The authors of the new paper fret that the Fed is fighting the last war.
“The absence of leverage may not be sufficient to ensure that monetary policy can disregard concerns for financial stability,” wrote Michael Feroli, chief United States economist at JPMorgan Chase, and three co-authors. “It does not follow that future bouts of financial instability will operate only through the same mechanism that was present in 2008 and 2009.”
Investors move in herds. Even without significant leverage, those movements can build sharply and recede sharply. As a result, the paper concludes, the summer disruption in financial markets when the Fed first hinted at its eventual retreat is likely to be repeated whenever the Fed moves toward raising interest rates.
“The risk is that if you go lower for longer you make the imbalance that you have to unwind bigger,” said another of the authors, Anil K. Kashyap, a professor of economics at the University of Chicago. “Maybe you unwind it at a time that the economy is stronger. But if people are irrational, you’re going to get more of this herding and the negative effects are going to be worse.”
Jeremy C. Stein, a Fed governor, said at the conference that he agreed that leverage was not a necessary ingredient for problems to emerge. He said there was a basic asymmetry in the way markets were responding to Fed policy: Interest rate spreads were contracting gradually as the Fed eased policy, but had the potential to bounce back rapidly as the Fed began to tighten.
But Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, questioned whether these market disruptions would damage the broader economy — and if not, whether the Fed should care.
Mr. Kocherlakota also said that the Fed had “two to three” years to sort through the issues because economic conditions continued to require aggressive stimulus.
The Fed said in December 2012 that it planned to keep short-term interest rates near zero at least as long as the unemployment rate remained above 6.5 percent. One year later, the Fed added that it planned to keep rates near zero well after unemployment drops under that mark. The rate was 6.6 percent in January.
Officials agree the Fed now needs to say more. The challenge is that investors respond to clear and simple guidance but, as the economy heals, the Fed wants to preserve flexibility to calibrate its campaign.
Charles Evans, president of the Federal Reserve Bank of Chicago, said on Friday that the Fed needed clear and simple goals, although he did not propose a specific set of new thresholds. He also called for the Fed to make clear that it would tolerate inflation above its 2 percent target to increase employment more quickly.
“These messages,” he said, “need to be repeated — over and over again.”
Mr. Plosser, a skeptic about the need for additional efforts to stimulate the economy, said he believed the challenge was more fundamental. Even if the Fed is clear, it will not be seen as credible, because investors will regard its guidance as a forecast contingent on economic conditions and not a commitment.
“Policy makers cannot maintain discretion and simultaneously commit to forward guidance and expect that guidance to be effective,” he said.