by Bill McBride on 9/19/2015 05:45:00 PM
Saturday, September 19, 2015
First San Francisco Fed President John Williams explains why he is willing to be patient on rate hikes: China, Rates, and the Outlook: May the (Economic) Force Be with You
Regarding monetary policy, we’re balancing a number of considerations, some of which argue for greater patience in raising rates and others that argue for acting sooner rather than later. Our decisions reflect a careful judgment about the relative risks and merits of those factors.Second, St. Louis Fed President James Bullard President explains why he supported a rate hike: St. Louis Fed's Bullard Discusses Normalization of U.S. Monetary Policy
I’ll start with the arguments for continued patience in removing monetary accommodation. First, we are constrained by the zero lower bound in monetary policy and this creates an asymmetry in our ability to respond to changing circumstances. That is, we can’t move rates much below zero if the economy slows or inflation declines even further. By contrast, if we delay, and growth or inflation pick up quickly, we can easily raise rates in response.
This concern is exemplified by downside risks from abroad. One such risk is the financial turmoil and economic slowdown in China, which I’ll get to shortly. More generally, economic conditions and policy overseas, from China to Europe to Brazil, have contributed to a substantial increase in the dollar’s value, which has held back U.S. growth and inflation over the past year. Further bad news from abroad could add to these effects.
That brings me to inflation, which has been under our target for over three years. This is not unique to the United States—inflation is very low in most of the world. Although we can ultimately control our own inflation rate, there’s no question that globally low inflation, and the policy responses this has provoked, have contributed to put downward pressure on inflation in the U.S. Although my forecast is that inflation will bounce back, this is only a forecast and there remains the danger that it could take longer than I expect.
Those are arguments on the side of the ledger arguing for more patience. On the other side is the insight of Milton Friedman, who famously taught us that monetary policy has long and variable lags. I use a car analogy to illustrate it. If you’re headed towards a red light, you take your foot off the gas so you can get ready to stop. If you don’t, you’re going to wind up slamming on the brakes and very possibly skidding into the intersection.
In addition, an earlier start to raising rates would allow us to engineer a smoother, more gradual process of policy normalization. That would give us space to fine-tune our responses to react to economic conditions; raising rates too late would force us into the position of a steep and abrupt hike, which doesn’t leave much room for maneuver. Not to mention, it could roil financial markets and slow the economy.
In considering the monetary policy choices, it’s important to remember that we’re in a very different place now than when we first instituted extremely accommodative policy. The economy has come a long way since the dark days of late 2009, when unemployment hit its 10 percent peak. Now we’re down to 5.1 percent and we’ve added over 12 million jobs, more than three million of them last year. Even better, most of those were full-time. It’s been a tough journey back, and monetary policy has played a crucial role in healing a once-ailing economy.
In the past, I have found the arguments for greater patience to clearly outweigh those for raising rates. The labor market was still far from full strength and the risk to the recovery’s momentum was very real. As the economy closed in on full employment, the other side of the ledger started gaining greater weight and the arguments have moved into closer balance.
Looking forward, I expect that we’ll reach our maximum employment mandate in the near future and inflation will gradually move back to our 2 percent goal. In that context, it will make sense to gradually move away from the extraordinary stimulus that got us here. We already took a step in that direction when we ended QE3. And given the progress we’ve made and continue to make on our goals, I view the next appropriate step as gradually raising interest rates, most likely starting sometime later this year. Of course, that view is not immutable and will respond to economic developments over time.
“The case for policy normalization is quite strong, since Committee objectives have essentially been met,” he said during his presentation titled, “A Long, Long Way to Go.”Bullard is not a voting member of the FOMC this year.
However, he noted, “Even during normalization, the Fed’s highly accommodative policy will be putting upward pressure on inflation, encouraging continued improvement in labor markets, and providing the best contribution to global growth that we can provide.”
Bullard noted that the FOMC wants unemployment at its long-run level and inflation at the target rate of 2 percent. “The Committee is about as close to meeting these objectives as it has ever been in the past 50 years,” he said.
To measure the distance of the economy from the FOMC’s goals, Bullard used a simple function that depends on the distance of inflation from the target rate of inflation and on the distance of the unemployment rate from its long-run average. This version puts equal weight on inflation and unemployment and is sometimes used to evaluate various policy options, Bullard explained. ...
While the objectives for unemployment and inflation have essentially been met based on those calculations, Bullard noted that monetary policy settings remain far from normal.
Even once the FOMC begins to normalize, Bullard emphasized, this will still mean a very accommodative policy stance. “Policy will remain exceptionally accommodative through the medium term no matter how the Committee proceeds,” he said. “This means there will continue to be upward pressure on inflation and downward pressure on unemployment.”
I thought it was likely that the FOMC would hike rates in September, mainly because several FOMC members said they'd hike rates if the economy evolved as expected (the revisions to the projections mostly suggest a better than expected economy!).
However, I think the risks are asymmetrical (better to hike later than too soon) and there is little risk from inflation, and that argues for a little more patience.
Posted by Bill McBride on 9/19/2015 05:45:00 PM