The Fed's political pause paves the way for a general overhaul

NEW YORK / SAN FRANCISCO (Reuters) – Last month, US Federal Reserve decision-makers suspended their three-year rate hike and ended their $ 4 trillion bankruptcy move. by increasing the risks for US economic growth. need more time to sort the data.

But, either by choice or by chance, their political break decisively eliminates the task of the central bank in anticipation of a complete overhaul of the way it manages the US economy, including the tools it uses. and how it communicates with the public.

The Fed's decision to spend the next year rethinking how it should ensure prices remain stable and employment is abundant is behind the same structural economic changes that led the US central bank to suspend its current policy.

The links between the Fed's new 'patient' policy stance, its decision to leave its balance sheet heavier than expected, and what should be a tough debate on a possible new policy framework were fully exposed for the first time . at a conference Friday on monetary policy in New York.

In this country, the influential head of the New York Fed, John Williams, spoke of the new normalcy of the US economy, where unemployment reached its lowest level in nearly 50 years, but inflation has not hardly achieve the Fed's goal.

And while the Fed must guard against soaring inflation, Williams said, "we must also ensure that inflationary expectations are not anchored at too low a level".

San Francisco Fed President Mary Daly also spoke at the conference.

"Inflation has been under our lens for a long time," said Daly. "Complacency can go both ways and it's important to be vigilant on both sides of the target, not just upward but downward."

Whether the Fed should react to periods of low inflation by keeping inflation on the sidelines, said Fed Vice President Richard Clarida in a speech on Friday outlining the broad-based revision of the Fed.

Such a strategy could mean that the Fed seeks to maintain an average inflation rate of 2% over a period of time, rather than its current strategy of targeting its 2% level without asking whether it has been able to This goal up to now.

Although Clarida has suggested the outcome of the monetary policy review, which is expected to be completed by the first half of 2020, it is possible for the Fed to adhere to its current policy. "We believe that the Fed would not ask this question if it did not already have the impression that a different solution could be justified," wrote Michael Feroli, Chief Economist of JP Morgan, in a note addressed to customers.

However, it is clear from the statements made by policy makers at the event that not everyone was convinced of the need to change the Fed's targeting of inflation, and the debate, which officially kicks off with an event Monday in Dallas, will be vigorous.

An economic report released Friday by the Fed showed why worries about low inflation suddenly took hold. After raising rates as part of a faster than expected growth until 2018, the Fed said a series of developing risks was likely to slow down the economy. towards the end of the year and until 2019.

This included the weakening of consumer spending and business investment, the risks badociated with the global slowdown and trade tensions, the "deterioration" of investors' risk appetite, and even a reduction in gross domestic product attributable to partial closure of the government.

Just as policy makers' new mistrust of slow growth and low inflation has helped shape the Fed's promise of "patience" for future rate hikes, this may have also played a decisive role in the federal government's desire this year.

Investors have complained in recent months of tighter financial conditions as a result of the Fed's declining balance sheet, swollen by trillions of dollars in bond purchases in the post-crisis years.

In their remarks on Friday, Philadelphia Fed President Patrick Harker and Fed Governor Randal Quarles suggested ending the balance sheet cuts for technical reasons related to the amount of liquidity that banks and the Fed need for the markets to work well.

The St. Louis Fed President, James Bullard, went so far as to suggest that the size of the balance sheet has only a "minor" impact on the economy, now that the Interest rates are well above zero.

But earlier this month, Daly from the San Francisco Fed and Lael Brainard, the Fed's Governor, showed that at least some policymakers wanted a relaxation of the balance sheet structure as part of a general desire to stop to tighten monetary policy.