President of NY Fed Says Hard-Landing a Possibility

In an April 1, 2005 speech entitled "Perspectives on Monetary Policy," Timothy F. Geithner, the President of the New York Federal Reserve Bank, talked about potential challenges for monetary policy in the years ahead:

Remarks by Timothy F. Geithner before Princeton University's Center for Economic Policy Studies

The major economic policy challenges facing the nation today … low public and household savings, concerns about educational quality and achievement, high and rising income inequality, the large imbalances between our social insurance commitments and resources—are not about monetary policy…

…We face a number of transitions ahead that will have important implications for U.S. monetary policy. Among these are:

• The transition from a long period of exceptionally low short-term nominal and real interest rates in the major economies and in many emerging market economies as well. Real short-term interest rates in much of the world, as in the United States, are still some distance below the band of estimates of equilibrium.
• The approaching demographic pressures on fiscal resources, which will hit most major economies at a time when underlying fiscal positions are still likely to be in substantial deficit.
• The inevitable evolution in the exchange rate regimes of China, and the substantial number of countries that have been actively targeting their nominal exchange rate against the dollar, to a system where there is more variability in their bilateral and real effective exchange rates.
• The disposition of the global imbalances reflected most conspicuously in the U.S. current account deficit.

These are all types of disequilibria. They can be sustained for a time, but not indefinitely. They could be diffused gradually and smoothly. But the transitions to a more sustainable equilibrium could also bring a risk of greater volatility in asset prices, less stability in macroeconomic outcomes, and more uncertainty. This could mean a less benign future environment for U.S. monetary policy…

So, he is identifying both a soft-landing (“diffused gradually and smoothly “) and a hard landing scenario (“greater volatility in asset prices, less stability in macroeconomic outcomes, and more uncertainty”). Which does he foresee as most likely? He says:

…there is much we do not understand about how these transitions ahead will unfold—in fiscal positions, the U.S. external imbalance, and in the exchange rate system and portfolio preferences. The recognition that things that are not sustainable will eventually come to an end does not give us much of a guide to whether the transition will be calm or exciting…

He doesn’t say which is more likely, but he clearly believes that the hard-landing scenario is a possible outcome, and one to be worried about. As for monetary policy in face of this uncertainty:

…These dimensions of the broader context in which we will be making monetary policy in the years ahead put a very important premium on keeping U.S. monetary policy as close to the frontier of credibility as possible. And this suggests we need to continue to examine the case for a measured further evolution in the U.S. monetary policy framework—evolution in the direction of finding ways to provide more clarity about our long term inflation objective…

This is an indication that the Fed will move towards more explicit inflation targeting and increased transparency as a means of avoiding macroeconomic fluctuations in the years ahead. But there is also an indication that the Fed is wary of the possibility that such measures will not be enough in a hard-landing scenario:

The challenge in thinking about what's next in any further evolution in our regime is about how to ensure that U.S. long-term inflation expectations remain stable at a level close to reasonable definitions of price stability, while retaining the flexibility to act wisely, but with speed and force and creativity in response to changing circumstances.

That the Fed wants monetary policy to evolve so that it can be implemented "with speed and force and creativity in response to changing circumstances" gives an indication the Fed is taking the possibility of a hard-landing seriously and working actively on how best to respond should it occur.

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