At top of the Fed, a dispute on policy picks up steam

“It’s important to distinguish between the current strong economic conditions and the key longer-run drivers underpinning interest rates,” he said at the Economic Club of Minnesota. Despite economic tailwinds like tax cuts and government spending, “the longer-run drivers still point to a ‘new normal’ of a low (neutral rate) and relatively low interest rates.”

Williams, whose research has helped convince most of his colleagues that the neutral rate of interest is much lower than in the past, stands to become even more influential when he takes over as chief of the New York Fed next month, a position that will make him a permanent voter on the Fed’s policy-setting committee.

His view contrasts with recent optimism from some economists and central bankers. Among them is the Fed vice chair for financial supervision, Randal Quarles, a Trump administration appointee who in February said he believed there is a “real possibility” that the economy could shift to a higher growth trajectory.

Quarles’ view suggests that the Fed has a bit more room to raise rates without braking the economy, which would, in turn, give it the flexibility to cut rates more deeply in the next downturn, and perhaps avoiding the need for unconventional measures like bond purchases.

Fed Board nominee Richard Clarida, at his confirmation hearing on Tuesday, flagged some discomfort with such measures, which began in the depths of the financial crisis to stabilize banks and were later were expanded to help bring down high unemployment and lift excessively low inflation.

Though the Fed’s initial program of so-called quantitative easing “made sense,” Clarida said he was not sure how he would have voted on subsequent rounds, and said in response to a question from Republican Senator Pat Toomey that he was “very sympathetic to your view that any discussion and thinking about QE would have to take a serious look at costs as well as benefits.”

Williams for his part on Tuesday called bond-buying an important part of the policy-easing tools that the Fed “is going to have to turn to” to fight future downturns.

Rate cuts alone, from what will be a relatively low starting point and only able to fall as far as zero, would not provide enough firepower to stimulate the economy, he has said in the past.

Williams has also said that “time is pressing” for a rethink of the Fed’s 2 percent inflation target. A new policy framework, he has said, conceivably could give the central bank more room for maneuver even with a low neutral rate by allowing it to defer rate hikes after a recession even if inflation pushes up to, or even past, its long-run target.

Several other Fed policymakers, including Fed Governor Lael Brainard and Chicago Fed President Charles Evans, have lent support to a debate on the framework.

Quarles by contrast has suggested that there is little need to rethink the framework if inflation rises back to the Fed’s 2 percent target, as it has lately done.

Clarida did not weigh in on that debate on Tuesday, or on his view of the neutral rate. But if he and fellow nominee Michelle Bowman are confirmed it is a topic that will heat up in coming months.


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