By Trevor Hunnicutt
(Reuters) - A top Federal Reserve policymaker is making the case for changing how the Fed responds to periods of tepid inflation by keeping interest rates "lower for longer."
New York Fed President John Williams (NYSE:WMB) said in a research paper https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr887.pdf he co-authored and distributed on Friday that policies that "raise inflation expectations by keeping interest rates 'lower for longer' after periods of low inflation" can keep people's expectations for prices at the right levels and reduce the negative effects of near-zero interest rates on the economy.
The research, which Williams will present at a conference at Stanford University in California on Friday, is geared toward a broad Fed policy review of how to get inflation to rise to and remain at its 2% target. That review may take many more months to complete.
At the same time, Fed officials are discussing the more immediate issue of whether a rate cut might eventually be needed to keep prices rising at levels policymakers support. The White House has publicly called for the Fed to cut rates to support growth, with U.S. Vice President Mike Pence renewing those calls on Friday.
"There's no inflation; the economy is roaring," Pence said in an interview with CNBC. "This is exactly the time, not only to not raise interest rates, but we ought to consider cutting them."
The Fed's preferred measure of inflation, the "core" personal consumption expenditures (PCE) price index excluding the volatile food and energy components, slowed to an annual rate of 1.6% in March.
Some policymakers and analysts think the Fed is better equipped to respond to upward spikes in prices than to persistently low readings. That is because rate cuts lose their potency as borrowing costs approach zero. Any alternatives to the Fed's current approach could be controversial.
Williams’ paper develops an argument he has made before that people can start to expect central banks to miss their inflation target in periods where rates near zero, potentially hurting economic growth over time. But by aiming for inflation above the target during good times, policymakers eliminate weak inflation expectations and reduce the harm to the economy. Williams is vice-chairman and a permanent voting member of the Fed's policy-setting committee.
The issue is not strictly academic. The Fed now targets short-term rates from 2.25-2.50% and they could easily cut to near-zero again in response to the next recession.