Charlie Evans on the Past, Present, and Future of U.S. Monetary Policy
Dec 11, 2023
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Charles Evans, former president and CEO of the Chicago Fed, discusses his work on US monetary policy. Topics include the creation of the Evans rule, the current path of R-Star, and the future of the Fed's framework. They also explore the importance of the explicit 2% inflation target and propose nominal GDP targeting as a solution for supply-side driven inflation.
Transition to larger balance sheet and asset purchases stabilized economy and required shift in operating system.
Adoption of flexible average inflation targeting aimed to achieve average inflation rate of 2% over time and strengthen anchoring of inflation expectations.
Deep dives
Importance of Explicit Inflation Target
The explicit 2% inflation target adopted in 2012 was a significant development in anchoring inflation expectations. It provided clarity and transparency in the Fed's objective, ensuring that inflation variability does not influence economic decision-making. By making the target explicit, it helped shape monetary policy decisions and provided guidance to market participants. The commitment to a specific numerical target, combined with an emphasis on symmetry, has proven effective in maintaining inflation expectations and guiding policy actions.
Transition to Large-Scale Asset Purchases
The transition to a larger balance sheet and the implementation of large-scale asset purchases in response to the financial crisis was a significant change for the Fed's monetary policy. This unconventional measure was necessary due to the zero lower bound constraint and played a crucial role in stabilizing the economy. It required a shift in the operating system from a scarce-reserve corridor to an ample-reserve or floor system. While there were debates and uncertainties surrounding the size and duration of the asset purchases, the overall objective was to provide accommodation, anchor inflation expectations, and support economic recovery.
Flexible Average Inflation Targeting
The adoption of flexible average inflation targeting by the Fed marked another important shift in the monetary policy framework. It recognized the importance of allowing inflation to moderately overshoot the 2% target after a period of undershooting. The aim was to achieve an average inflation rate of 2% over time, creating flexibility to respond to economic conditions. By explicitly stating the commitment to average inflation targeting, the Fed signaled its willingness to accommodate temporary deviations from the target in order to achieve longer-term price stability. This framework adjustment aimed to strengthen the anchoring of inflation expectations and promote a more symmetric approach to policy.
Evans Rule Percolating into the FOMC
The podcast episode discusses the origins of the Evans rule and its official adoption by the FOMC in December 2012. The Evans rule, proposed by Charles Evans, stated that the FOMC would hold interest rates at 0% until unemployment fell below 6.5% or inflation rose above 2.5%. The idea was to provide guidance to the markets and ensure more accommodation to stimulate the economy. Evans spent a year advocating for this rule, emphasizing the need for more policy intervention and quantitive easing to address economic challenges.
Challenges with Monetary Policy and Inflation Targeting
The podcast also delves into the challenges faced by the Fed in setting monetary policy and targeting inflation, particularly during periods of supply-side shocks and sticky prices. The flexible average inflation targeting framework, implemented by the Fed, led to delays in tightening monetary policy. The Fed had to navigate uncertainties in estimating the natural rate of unemployment (our star) and determining the appropriate level of accommodation. The discussion explores the possibility of adjusting the framework in the upcoming 2024-2025 review, considering options such as nominal GDP targeting and the use of a broader range of indicators for inflationary pressures.
Charles Evans was a 31-year veteran of the Federal Reserve System, serving as a researcher, vice president, and, ultimately, president and CEO of the Chicago Fed from 2007 to 2023. Charles joins Macro Musings to talk about his past and ongoing work on US monetary policy. Specifically, Charles and David discuss his work as a regional bank president and a member of the FOMC, the creation and adoption of the Evans rule, the current path of R-Star, the future of the Fed’s framework, and more.
