Goodfriend: Dovish in the Near Term, Hawkish in the Medium Term

Last night, the White House sent Marvin Goodfriend’s nomination to the Senate. Goodfriend does not fit easily into traditional molds for monetary policymakers. One misconception is that he’s a traditional hawk,  the type that tends to place far greater weight on limiting above-target inflation than almost anything else. In the near term, Goodfriend is actually more likely to be an inflation dove.  

That is because, foremost, he is concerned about defending the credibility of the Fed’s 2% inflation target and truly sees it as an asymmetric objective. He doesn’t possess the innate asymmetric aversion to above-target inflation that characterizes traditional hawks. He does not have much faith in the Phillips curve-based forecasts that a tighter labor market will lead to higher inflation. Rather, he wants to see “direct evidence” of a return of inflation to 2%. He is concerned about inflation expectations falling because of a perception of greater deflation risks owing to the greater likelihood of the Fed being constrained by the effective lower bound. As such, we would surmise that he would likely see two to three hikes as appropriate in 2018 (assuming a  December 2017 hike), which would be a bit lower than the median. 

Keep in mind that, if confirmed, he would be one of only four governors and one of only two career economists  (the other being Brainard), so his intellectual views could carry more weight than is usually assigned to a  governor. 

Over the longer term, some of his views will likely tend to be more in line with a currently prevailing Republican perspective. He used his March 2017 testimony in part to argue for Fed accountability to a Taylor Rule model.  Additionally, he is skeptical of the efficacy of QE and especially of MBS purchases, which he sees as akin to credit allocation and fiscal policy. This points to a slight upside risk to the fund’s rate path and downside risk to portfolio holdings (especially MBS) over the longer term.  

However, while Goodfriend has conservative inclinations in some respects, such as wanting the Fed to avoid allocating credit, he is no orthodox. He sees the effective lower bound on nominal interest rates as an unnecessary constraint on monetary policy. His outside-the-box proposals on allowing negative rates would be quite contentious, and highly unlikely to prevail, at least over the medium term. In addition to convincing his colleagues, Goodfriend would have to convince Congress (and perhaps the public). Some believe that the Federal Reserve Act does not permit negative interest rates. However, that will have to be resolved, given that we expect a negative funds rate will be “on the table” the next time it reaches zero. So we will want to watch to see how the Committee’s views evolve on that, especially as the vacant seats are filled. 

What most defines his views, at least more accurately than the standard “dovish” or “hawkish,” would be an aggressiveness whenever inflation credibility is threatened, in either direction. His priority is, always and above all, maintaining the credibility of the FOMC’s 2% inflation objective. That means especially being aggressive and preemptive policy at a zero funds rate when deflation risk arises, even to the point of a  substantially negative policy rate.  

Indeed, he proposes structural changes that would, in effect, lower the effective lower bound, permitting a  substantially negative and sustainable policy rate to allow monetary policy to operate more effectively in a  low inflation environment. These proposals go to the extreme point of abolishing currency; otherwise,  effectively taxing currency holdings, or having the Fed introduce its own digital currency. This would become more of a research priority for the Fed staff. However, these proposals are not likely to be practical any time soon and are not likely to be high on the Fed’s agenda in the near future. 

He has also made a number of proposals for revisions to the Statement on Longer-Run Goals and Monetary  Policy Strategy that he believes would strengthen the FOMC’s commitment to and the public’s appreciation of that commitment to price stability. These proposals go from very sensible ones, likely to be adopted, to the, well, never-to-be-adopted and barely even worth mentioning.  

1. He said that the Statement should add another principle, specifically, that an explicit inflation goal  “helps keep longer-term inflation expectations firmly anchored.” We expect he will get that revision in January.  

2. He said the Statement should no longer say that “The [FOMC] intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.” He will likely get some adjustment on this front.  

3. He proposed that the FOMC declare its intention to invite the legislature to accept the inflation target to further enhance the target’s credibility. This does not seem at all likely.  

4. He proposed that the FOMC “declare its intention to strengthen the legislative oversight process to help enforce the systematic pursuit of monetary policy.” We doubt his fellow FOMC participants would share his enthusiasm for additional legislative “help,” and his own enthusiasm could well be dimmed by greater exposure to Congress. 

5. He proposed that the FOMC present its independently-chosen monetary policy decision against a  familiar Taylor-type rule for monetary policy. Not a chance!  

Dovish in the near term: He doesn’t buy most explanations for why core inflation is transitorily low. And he would likely prefer the FOMC delay raising rates until inflation is confirmed to be higher by the incoming data rather than simply forecasted to rise.  

Hawkish in the medium term, and perhaps soon! When inflation rises toward 2% and inflation expectations stabilize at 2%, he will be most concerned with falling behind the curve. Although he would prefer to be preemptive, by then the FOMC might have to be reactive. He has publicly stated his preference for moving quickly and decisively to normalize policy when circumstances suggest that this is necessary; he often cites the favorable result of the Fed’s tightening in 1994-95. So he could easily jump from dovish to hawkish next year if inflation is clearly on its way back to 2 percent. 

While we expect he could be outside the consensus when the Committee is raising or lowering rates, he would be an excellent colleague. Given his strongly held views, he will have a higher propensity to dissent than we have seen from governors for some time, perhaps higher than that of most presidents as well!

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