By Greg Robb, MarketWatch
Federal Reserve Gov. Lael Brainard on Friday said she favored a very aggressive policy approach to the next recession that would include capping interest rates beyond short-term rates, a policy k nown as yield-curve control.
In a speech at a conference examining how the Fed should react in the next downturn, Brainard said the Fed should also pledge to keep interest rates at zero until the Fed achieves its targets of full employment and a 2% annual inflation rate.
This could leave rates near 0% for a long time. The Fed has yet to hit its 2% inflation target a decade after the 2008 financial crisis. And many economist don’t think full employment has been reached either.
“The lessons from the crisis would argue for an approach that commits to maintain policy at the lower bound until full employment and target inflation are achieved,” Brainard said.
In addition, Brainard said the Fed would control the yield curve until it achieved its goals. She suggested the Fed would focus on the short-end of the curve.
“This forward guidance could be reinforced by interest rate caps on short-term Treasury securities over the same horizon,” the Fed governor said.
The Fed didn’t attempt yield-curve control during the 2008 financial crisis. Instead, officials used quantitative easing, or QE, which was the purchase of government securities to drive down interest rates. The last time yield curve control was used was during World War II, when the government needed low interest rates to fund the war effort.
Under the yield-curve control policy, the Fed would target some longer-term yield and tell the market that it would buy bonds to keep the yield from rising above target.
In theory, the central bank might not have to buy many bonds if the market believed the pledge was credible.
A paper released by prominent economists at the conference Friday argued for just such an aggressive approach using these new tools.
Torsten Sløk, chief economist at Deutsche Bank Securities, said the fact that yield-curve control was being considered was “a sign of desperation” that current tools are insufficient to combat another recession.
For instance, there is concern that controlling the short-end of the yield curve would result in a “kink” that would push rates up for maturities the Fed had not capped.
Two Fed officials said Friday they aren’t worried about a recession in the near term, although the coronavirus is a risk to the outlook.
Atlanta Fed President Raphael Bostic said the economy was showing steady, strong, growth.
“The economy is strong. It can stand on its own feet and it can grow pretty consistently. And so we should let it do that,” he said, in an interview on CNBC. He said the COVID-19 outbreak would likely result in a “short-time hit” for the economy.
St. Louis Fed President James Bullard also said on CNBC that the coronavirus impact on economic growth would be temporary.
Investors are more worried about the epidemic emanating from China that is impeding international trade and travel. Stocks /zigman2/quotes/210598065/realtime DJIA -0.07% were down firmly on Friday afternoon as worries about the coronavirus intensified.