SAN FRANCISCO – The Federal Reserve’s Charles Evans entered the lion’s den of monetary orthodoxy to make his pitch: Unemployment must come down, even at the cost of temporarily higher inflation.
Among those at the March European Central Bank symposium in Frankfurt was Otmar Issing, the central bank’s former top economist and one of Europe’s fiercest inflation fighters.
Some months before, the idea of tolerating rising prices had been branded irresponsible by Paul Volcker, who as Fed chairman in the 1980s induced a recession to protect the value of money.
With Otmar in the audience, I was nervous, Evans, president of the Chicago Fed, recalled later. Yet he pressed on, telling his audience, monetary policy can and should take additional steps to facilitate a more robust economic expansion.
Evans’ appearance in Frankfurt was one of 13 stops in a more than yearlong odyssey that took him from Detroit to Bangkok to push an untested policy tool: linking the outlook for interest rates to unemployment and inflation.
The Fed finally heeded his call Dec. 12, deciding to keep rates near zero as long as unemployment remains above 6.5 percent, inflation is no more than 2.5 percent and long-term inflation expectations are well anchored.
It’s a strategy that we believe will help support household and business confidence and spending, Chairman Ben Bernanke said after a meeting of the Federal Open Market Committee that day.
The decision was a testament to what former colleagues call Evans’ ability to build consensus. It also shows how one of the Fed’s 12 regional bank presidents can influence policy that is usually set by the central bank’s Washington-based board of governors, led by Bernanke.
Through the power of his ideas and his powers of persuasion, President Evans was gradually able to gain some momentum behind this idea in the Fed, said Carl Tannenbaum, chief economist at Northern Trust Corp. in Chicago, where he was an economist and supervisor for the central bank.
Evans’s campaign wasn’t the first time he has pushed against accepted economic ideas. Evans in his doctoral dissertation at Carnegie Mellon University argued that Nobel-winning economists Edward Prescott and Finn Kydland had overstated the impact of technology in driving the business cycle. Monetary policy also plays a part, Evans said.
Even then, you could see that Charlie was struggling to get out of the mainstream view at Carnegie if not the world, said Martin Eichenbaum, who was Evans’ thesis adviser and is now a professor at Northwestern University in Evanston, Ill. He was questioning conventional wisdom back then, and that’s what he’s doing now.
Evans declined a request for an interview, according to Chicago Fed spokeswoman Laura Labarbera.
The adoption of Evans’ proposal to link rates to unemployment was another foray into unprecedented measures for Bernanke’s Fed. Since 2008, Bernanke has cut the main interest rate to zero and bought more than $2.3 trillion in securities to fuel growth.
Yet more than three years after the recession ended, unemployment remains at 7.7 percent, far above the Fed’s estimate of long-run unemployment at no more than 6 percent.
More than three years of recovery hadn’t erased the enormous waste of human and economic potential from high unemployment, Bernanke said in a news conference Dec. 12 after the Federal Open Market Committee released its statement.
Evans started advocating his approach a month after one of the most controversial committee decisions under Bernanke’s chairmanship.
In August 2011, as the recovery showed signs of faltering, the committee said it would hold the main interest rate near zero through at least mid-2013, tying policy to a calendar date for the first time.
While Evans supported that idea, he wanted to go further. The next month, he made his first public call for Fed officials to step up accommodation by pledging to keep rates at zero until reaching a certain level of unemployment.
Research by economists such as Michael Woodford, now at Columbia University in New York, had shown that when the short-term interest rate is already near zero, a central bank can ease policy further by committing to keep stimulus in place.
The unemployment rate, at 9 percent at that time, should have our hair on fire, Evans said in London in September 2011.
The clock is ticking – the longer we wait, the more likely it is that unutilized skills diminish to the point that more permanent damage takes hold.