Federal Reserve

Why the Fed might need to cut rates to minus 2 percent: Former Fed economist

Would the US ever see negative rates?
Would the US ever see negative rates?

The U.S. Federal Reserve might need to cut interest rates to as low as negative 2 percent, far lower than levels other global central banks have tested, a former Fed economist said.

That's what would likely be needed to engineer a recovery if the U.S. economy were to fall into a recession in the next couple of years, Marvin Goodfriend, who was an economist and policy advisor at the Federal Reserve's Bank of Richmond from 1993-2005, told CNBC's "Squawk Box" on Thursday.

Goodfriend, who is currently a professor of economics at Carnegie Mellon University, pointed to data on the eight recessions in the U.S. since 1960.

"In eight of those recessions, the Fed had to push the short rate 2.5 percentage points below the long term rate. Today, the 10-year rate in the U.S. is 1.5 percent," he noted, saying that would indicate that during the next recession, the Fed would need to cut rates as low as minus 1 percent at a minimum.

"In five of those recessions, the Fed had to push the federal funds rate 3.5 percentage points below the 10-year bond rate," he said. "So if that happens this time around, we would have to push the federal funds rate to minus 2 percent."

That's well below where any other central banks have ventured so far. Sweden's central bank, an early adopter of negative rates, has set its benchmark at negative 0.5 percent. The Bank of Japan's rate was set at minus 0.1 percent earlier this year, while the European Central Bank, which first moved its rates into negative territory in 2014, currently has a deposit rate of negative 0.4 percent.

The Fed funds rate has remained in positive territory, with the U.S. central bank last increasing interest rates in December of 2015, its first hike since 2006. That raised the Fed's target rate to a range of 0.25 to 0.5 percent.

To be sure, Goodfriend didn't expect the Fed would be headed there anytime soon, noting that he believed the central bank should actually raise rates before the end of the year.

"The U.S. has near full employment and inflation is moving up toward target," he said. "My own feeling is that the Fed needs to show the flag against inflation, if only to move rates up only slightly, to show that it's on the job."

A display of $10 note currency plates from the past century are seen at a press conference at the National Archives on June 18, 2015 in Washington, DC.
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That's in line with statements from Fed officials during the annual central bank conclave in Jackson Hole, Wyoming, held last week.

At the meeting, Fed Chair Janet Yellen's speech opened the door to a September hike when she said the case for a rate increase had strengthened in recent months. Until then, many market players had poo-pooed chances that the Fed would hike this year or next.

Fed Vice Chair Stanley Fischer further pushed the Fed's September meeting into play when he said in a CNBC interview that Yellen's comments were consistent with a Fed that could hike rates at the Federal Open Market Committee meeting on September 20-21, and potentially a second time this year as well.

The U.S. nonfarm payroll jobs report for August, due Friday, will likely be closely watched for clues on whether the Fed will act later this month. On Wednesday, ADP released its private-sector jobs report showing companies added 177,000 positions in August, slightly above forecasts, while the July figure was revised higher to 194,000 from the initially reported 179,000.

But even as U.S. job creation appeared to be picking up, Goodfriend didn't expect longer-term interest rates would rise much, spurring his forecast for the Fed to potentially cut deeply into negative territory in the next recession.

"Long-term nominal rates are likely to stay very low or near zero for the foreseeable future," he said, citing low growth prospects, advanced economies' high debt overhang and higher future expected taxes.

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—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1