Federal Reserve Gov. Lael Brainard made the case on Thursday that the “new normal” of low interest rates requires the central bank to let inflation run hotter than usual as well as to employ tools like increased capital requirements to check financial market exuberance.
“In today’s new normal, it is important to achieve inflation and inflation expectations around our 2% target on a sustained basis while guarding against financial imbalances through active use of countercyclical tools,” she told a gathering of the National Tax Association in Washington.
In what Brainard calls the new normal, inflation hasn’t moved up consistently as the labor market has strengthened, and the long-run neutral interest rate that neither restricts nor stimulates the economy seems to be lower than it was historically. Another feature of the new normal is that underlying trend inflation is running below the Fed’s target.
In response, Brainard advocated what she called “opportunistic reflation,” which would take advantage of any above-target gain in core inflation to demonstrate that the Fed views its target as symmetric and not a ceiling.
Minneapolis Fed President Neel Kashkari made a similar point in his own speech on Thursday. “For our current framework to be effective and credible, we must walk the walk and actually allow inflation to climb modestly above 2% in order to demonstrate that we are serious about symmetry,” Kashkari told the Santa Barbara County Economic Summit.
Brainard, meanwhile, pointed out that in a low-rate environment, monetary policy won’t be able to restrain the financial cycle as much as previously. “In order to enable monetary policy to focus on supporting the return of inflation to our symmetric 2% target on a sustained basis along with maximum employment, we should be looking to countercyclical tools to temper the financial cycle,” she said.
The Fed so far has not used the countercyclical capital buffer tool given to it after the financial crisis.
“Turning on the CCyB [the capital buffer] would build an extra layer of resilience and signal restraint, helping to damp the rising vulnerability of the overall system,” she said. In March, Brainard was the only of the Fed’s board members who voted in favor of imposing the capital buffer, which could impose extra requirements of up to 2.5% of risk-weighted assets on the nation’s largest banks. The Fed votes on its imposition annually.
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