The Federal Reserve could keep interest rates exceptionally low through early 2016 if it followed a so-called optimal policy path, according to a senior Fed official.
Fed Vice Chair Janet Yellen in a speech Tuesday described the optimal path as one that keeps inflation closest to Fed's 2% target and the unemployment rate closest to 6%. "This highly accommodative policy path generates a faster reduction in unemployment … while inflation slightly overshoots the Committee's two percent objective for several years."
The early 2016 date is later than the Fed's current forecast, in which it says it expects rates to remain "exceptionally low" through mid-2015.
But such calendar date guidance could soon be eliminated, Yellen suggested. She said the Fed is considering scrapping calendar date guidance in exchange for economic targets such as inflation and unemployment.
Yellen, who heads a special committee inside the Fed considering communications strategy, said she "strongly supports" proposals to "eliminate the calendar date entirely and replace it with guidance on the economic conditions that would need to prevail before liftoff of the federal funds rate…" Such proposals have been made by Chicago Fed Presidents Charles Evans and Minneapolis Fed President Narayana Kocherlakota.
"I support this approach because it would enable the public to immediately adjust its expectations concerning the timing of liftoff in response to new information affecting the economic outlook. This market response would serve as a kind of automatic stabilizer for the economy,'' Yellen said.