The Fed: Fed’s Brainard says ‘new normal’ means central bank needs to let inflation run hotter, employ capital buffers

Lael Brainard, governor of the U.S. Federal Reserve, speaks during a Bloomberg Television interview at the spring meetings of the International Monetary Fund (IMF) and World Bank in Washington, D.C., U.S., on Thursday, April 11, 2019.

Federal Reserve Gov. Lael Brainard on Thursday made the case that the “new normal” of low interest rates requires the central bank to let inflation run hotter than usual as well 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, D.C.

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 on Thursday made a similar point in his own speech. “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 would build an extra layer of resilience and signal restraint, helping to damp the rising vulnerability of the overall system,” she said. Brainard in March 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.

The Dow Jones Industrial Average DJIA, +1.16%   has gained 10% this year and 291% from the 2009 bear-market low.

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