Drawing upon simulations from the paper itself, the Citigroup strategist argues the large‐scale asset purchases and forward guidance about the future path of the Federal funds rate would "have almost no ability to offset a shock in current circumstances," citing the fact that policy rates are likely to be coming off a lower base than the paper projects.
Markets are pricing in a 100 basis points Fed funds rate at the end of 2019, for example, compared with the FOMC's median Fed funds rate projection of 2.4 percent at the end of 2018.
Based on Reifschneider's model, Englander says the Fed would only be able to offset a 0.2 percent shock to the unemployment rate given both where rates are currently and Fed officials' commitment not to take rates into negative territory.
"In the simulation, QE and forward guidance take 10-year yields down 225 basis points to 300 basis points depending on the starting point for Fed funds and whether you do $2 trillion or $4 trillion for QE," he says. "But that is not going to work very well if, by design, Fed funds and 10 year yields can’t go below zero. And if expected rates are already low then forward guidance does not have much room" to stimulate the economy. In effect, Fed officials would have to "keep a straight face while saying they we will keep rates at zero … forever."
Hawks might seize on this paper to argue that rates should be raised sooner in order to give the Fed a bigger margin to cut rates in the event of an economic downturn, but Englander says the paper is another argument to continue stimulating the U.S. economy now so it's in a better shape to weather those futures shocks.
"Whether it is presented formally at Jackson Hole, or is in the background, it is likely to be viewed as presenting the baseline ability of the current set of policy parameters to affect outcomes," writes Englander.
Reifschneider himself says the Fed's ability to respond to a significant U.S. downturn could be weaker than the model suggests given structural weaknesses in the economy, "implying accommodative fiscal policy" would be needed.
This article was provided by Bloomberg News.