PEORIA, Ill. (Reuters) - A low interest rate environment sets limits on what the Federal Reserve can accomplish with monetary policy, making it important for the Fed to “proactively” cut rates when risks appear to provide a buffer for the economy, Chicago Fed President Charles Evans said Wednesday.
Evans said that when inflation is low, providing “too much accommodation” can help the U.S. central bank reach its inflation target sooner. In contrast, not acting strongly enough can cause inflation expectations to be anchored at low levels.
“In my view, these differences mean we need to err on the side of providing aggressive enough accommodation to get inflation moving up with some momentum,” Evans said at an event hosted here by the Greater Peoria Economic Development Council.
Speaking to an audience of local politicians and business leaders, Evans stressed the importance of responding quickly to downside risks, making the case that the Fed could raise rates later if needed.
“Engineering a modest overshoot of our inflation objective better guarantees that we would actually meet our inflation target in the future,” Evans said. “Any excessive overshooting could be controlled with modest rate hikes.”
Evans supported the two interest rate reductions approved by the Fed in July and September and said Wednesday that he thinks monetary policy is “probably in a good place right now.” The U.S. central bank’s target rate is now at a level between 1.75% and 2.00%.
Last week, Evans said he would go into the Oct. 29-30 meeting “open minded” about to whether rates should be adjusted in either direction. Investors are widely expecting officials to cut interest rates by a quarter of a percentage point at the October meeting.
Evans said he expects the U.S. economy to grow by above 2% this year and pointed to healthy consumer balance sheets and a strong labor market as bright spots. Still, he said that uncertainty over trade policy and a slowdown in global growth have led to a decline in business investment.
“There is some risk that the economy will have more difficulty navigating all the uncertainties out there or that unexpected downside shocks might hit,” Evans said. “So there is an argument for more accommodation now to provide some further risk-management buffer against these potential events.”
Evans said in an interview with reporters that the need for monetary stimulus could decline if there are positive developments in some of the conflicts threatening to slow the economy, including the trade war with China and Britain’s exit from the European Union.
The policymaker also said that Fed officials are still evaluating solutions for improving liquidity in money markets and studying why reserves are not circulating within the banking system.
The Fed announced last week that it will purchase $60 billion in short-term Treasury bills a month to bring the reserves in the banking system back to about $1.5 trillion, or the level seen in early September before there was a spike in borrowing rates for cash.
Evans said that financial regulations, such as Dodd Frank, have changed banks’ demand for reserves and stopped some banks with excess reserves from lending out the cash.
“It’s not just the level of reserves,” he said. “A second dimension to that is reserves are concentrated in a small number of the larger banks, and what is their appetite for arbitraging repo rates against other rates when they have regulatory requirements. The entire market functioning has changed over the last 15 or more years.”
Evans said he is “open minded” to the possibility of a standing repo facility, an approach that officials discussed in their June meeting that would allow financial firms to borrow cash at a fixed rate. But he said Fed policymakers still need to discuss how such a program would be structured and if it is needed to improve access to liquidity.
“I think we might struggle with this longer than we would like,” he said.
Reporting by Jonnelle Marte; Editing by Chizu Nomiyama and Lisa Shumaker