Michael Woodford on the new Fed policy

December 12, 2012

Michael Woodford, a Columbia University economist and leading monetary theorist, wrote a crucial paper at the Jackson Hole economic symposium in August arguing that central banks need to use their influence over expectations to boost the economy when interest rates are at the zero lower bound. In that sense, he is among the intellectual godfathers of the new Federal Reserve policy announced Wednesday. Wonkblog asked Woodford for his thoughts on the new strategy, in which the Fed said it expects to keep interest rates low until unemployment falls to 6.5 percent or inflation rises above 2.5 percent.


Michael Woodford / Columbia Univeristy

Here is his response, in an e-mail Wednesday afternoon:

As I've discussed before, I think there are important advantages of clarifying the criteria that will determine likely future policy. Today's statement provides important additional clarification of the conditions under which it will be appropriate to begin raising short-term interest rates, relative to the FOMC's statements in September and October. Such clarification is particularly likely to help stimulate the economy when, as in this case, it indicates that the conditions required for policy tightening will not be reached as early as some might have expected on the basis of past Fed behavior.

The explicit thresholds mentioned today are not ones that will be reached as soon as a federal funds rate above 25 basis points would be dictated by a reaction function estimated on the basis of the FOMC's pre-crisis decisions, and in that respect the announcement should change the forecasts of future Fed policy of at least some market participants.

A more explicit discussion should also reduce some of the considerable uncertainty about Fed policy that has resulted from the series of unprecedented actions taken over the past few years. While the quantitative thresholds announced are not the ones that I have advocated, they represent a substantial improvement upon the date-based approach to forward guidance that continued to be used in the September and October FOMC statements.

 The statement also clarifies that the federal funds rate target will remain low even after the asset purchase program ends; this has the advantage of allowing that program to end without the FOMC having to fear that this would be taken as a signal that interest-rate increases are also imminent. While there are no plans to end the asset purchases soon, I think it is important that the FOMC not be boxed in to a continuation of asset purchases at the current rate for as many years as might be needed to reach the thresholds required to justify raising short-term interest rates.

Zachary A. Goldfarb is a staff writer covering the White House, focusing on President Obama’s economic, financial and fiscal policy.
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Brad Plumer | December 12, 2012