The Federal Reserve could better time interest rate hikes following future recessions by pledging to hold fire until inflation rises above its target, Fed Governor Lael Brainard said on Thursday.
Brainard said her remarks were not meant to address current monetary policy and she focused on how the Fed should act after it has cut rates to zero and inflation remains persistently low.
Currently, the Fed is already several rate increases into a hiking campaign that began in 2015, although inflation has been stubbornly low.
But Brainard said policymakers will likely need to lower rates to near zero again in the future and will likely also struggle with worrisomely low inflation.
She said there were merits to a proposal by former Fed Chairman Ben Bernanke for the central bank to hold off on rate increases until inflation rises above target, making up for a period of undershooting the target. But she said this somewhat controversial approach also carried risks.
“The kind of policy framework that Bernanke proposes, which pre-commits to implementing the makeup principle based on the actual observed performance of inflation during a lower bound episode, could guard against premature liftoff and help prevent the erosion of longer-term inflation expectations,” Brainard said in prepared remarks.
She said this approach, however, could be difficult to communicate to public and to calibrate with other policies, such as asset purchases. Moreover, it might risk financial stability.
“The combination of low interest rates and low unemployment that would prevail during the inflation overshooting period could well spark capital markets to overextend, leading to financial imbalances,” Brainard said.