Washington Insider -- Thursday

Continuing Debate Over Monetary Policy

Here’s a quick monitor of Washington farm and trade policy issues from DTN’s well-placed observer.

US-Japan Trade Talks Conclude; More Talks Ahead

Top trade officials from the U.S. and Japan concluded two days of talks in Washington Tuesday, with officials indicating the discussions focused mainly on goods and some services.

"The United States and Japan discussed trade issues involving goods, including agriculture, as well as the need to establish high standards in the area of digital trade," the Office of the U.S. Trade Representative said in a statement. US Trade Representative Bob Lighthizer and Japan’s Economic Revitalization Minister Toshimitsu Motegi held the discussions, with USTR saying the US "raised its very large trade deficit with Japan — $67.6 billion in goods in 2018.”

Lighthizer and Motegi agreed to meet again "in the near future to continue these talks," USTR said, with Reuters reporting the talks would take place next week ahead of a session between Prime Minister Shinzo Abe and President Donald Trump. Japan's Motegi told reporters that he hoped to reach good results in the talks "at an early stage."

U.S. focus in the talks was on agriculture provisions rather than controversial issues such as pharmaceutical pricing or currency manipulation, according to contacts. While the US wants an “early harvest” to reduce its bilateral trade deficit, Japan will be unwilling to accept a one-sided deal where it cuts agriculture tariffs without getting anything in return.

EU Publishes List of Retaliatory Tariffs On US Food And Drink

The publishing of a list of U.S. products like dried fruit and vegetables, vegetable oils, nuts, fruit juices, wine and ketchup are among the U.S. food products that could be hit with additional import duties by the European Union relative to the dispute between the two over aircraft subsidies.

The EU took the step after the U.S. published a list of EU products totaling $11.2 billion that would be targeted for import duties after the WTO ruled that EU subsidies to Airbus did not meet their WTO obligations.

"European companies must be able to compete on fair and equal terms," EU Trade Commissioner Cecilia Malmstrom said. "The recent WTO ruling on U.S. subsidies for Boeing is important in this respect."

The EU will take comments on the list and will await a ruling by a WTO arbitrator on the level of retaliation that the EU can impose.

Washington Insider: Continuing Debate Over Monetary Policy

Washington has always been fascinated by monetary policy and all sides are fascinated by the changes being discussed now, Bloomberg says. It is reporting that Federal Reserve Chairman Jerome Powell and his colleagues “have made an important change in their strategy for dealing with inflation in a prelude to what could be a more radical change next year.”

In a shift, the central bank has backed off its former schedule of interest-rate hikes aimed at avoiding the potentially dangerous inflation that economic theory says could result from the hot jobs market. Instead, Powell & Co. have “put policy on hold until currently sub-par inflation rises convincingly,” Bloomberg says.

“The Fed is evolving to a ‘whites-of-the-eyes’ approach in terms of inflation” under which it won’t hike rates until price rises accelerate Stephen Stanley, chief economist at Amherst Pierpont Securities LLC told the press.

Powell and some of his colleagues have been perplexed and perturbed by the Fed’s failure to convincingly raise inflation to its 2 percent target and that’s what’s driving his seeming adoption of a show-me strategy on price pressures, Bloomberg says.

As the Fed embarks on a year-long review of its monetary policy framework, Powell has also shown willingness to seriously consider an approach under which the central bank would seek price rises “above its objective” for a while. Bloomberg concludes that “Powell’s change in tactics has potentially major ramifications for monetary policy, the economy and financial markets.”

“Monetary policy has the luxury to be able to accommodate growth rather than having to slow down growth because of inflation," said Angel Ubide, head of economic research for global fixed income at hedge fund Citadel. He expects the expansion to continue for several more years.

That would seem to be good news for President Donald Trump, who will campaign for re-election in 2020. But he’s not satisfied. He’s pressing the Fed to cut rates and resume bond purchases to turn the economy “into a rocket ship.”

There are risks to the Fed’s evolving approach, Bloomberg thinks. A policy that keeps rates lower for longer could spawn speculative asset bubbles and excessive leverage as investors are forced to take on more risk to earn the returns they’ve become accustomed to.

And, this is not a new debate. Then-Fed Chair Janet Yellen rejected a “whites of their eyes’’ strategy in 2016, arguing that the central bank needed to be pre-emptive in dealing with inflation because monetary policy acts with a lag. Powell, a central bank governor at the time, supported her.

The move to that strategy now in part reflects the fact that monetary policy is thought to be in a different place. Short-term rates are two percentage points higher than they were then and policy is now reckoned to be neutral for the economy, not ultra-easy.

But what’s more important is what hasn’t changed. Price pressures have remained muted – even though the economy is coming off its best year since 2005 and is on course to achieving its longest expansion ever.

That’s fanned fears among Powell and his colleagues that companies and consumers may lose faith in the central bank’s ability to deliver 2% inflation. Since that objective was introduced in 2012, annual price rises have averaged just 1.4%.

Too low inflation also keeps rates dangerously close to zero, Bloomberg notes. That gives the Fed scant room to cut in the next recession, meaning officials would once again have to resort to unpopular tools, such as bond purchases, to support the economy.

That’s at least partly the impetus behind the Fed’s decision to reconsider its inflation framework, Bloomberg says. While Powell has ruled out increasing the 2% goal, he’s raised the possibility that the central bank could adopt a “make-up’’ strategy when it concludes its review in the first half of 2020.

Such a strategy could take various forms but the simplest would involve the Fed seeking to achieve an average 2% inflation rate over the economic cycle and allow undershoots of the target when times were bad that would be offset by overshoots when times are good, as they are now.

“I’m high on that idea," Yellen told a Meridian International Center meeting on Tuesday in Washington, although it would be a marked departure from the Fed’s current let-bygones-be-bygones approach, where it tries to hit its symmetric 2% goal no matter what has happened before.

But for such a change to work, the Fed’s promise to deliver above-target inflation would have be seen as believable by the public. That might be a difficult sell unless the central bank first convincingly lifts inflation to its 2% objective -- something the move away from a policy of preemption is meant to achieve.

It is likely that strong tensions will continue between the Fed and the executive, especially since fears of out of control inflation are so deeply held by the public. Certainly, this intense monetary policy debate should be watched closely by producers as it intensifies, Washington Insider believes.

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