Thursday, November 12, 2015

Fed's Dudley and Evans

by Bill McBride on 11/12/2015 12:29:00 PM

First, from the WSJ Economists Overwhelmingly Expect Fed to Raise Interest Rates in December

About 92% of the business and academic economists polled by The Wall Street Journal in recent days said they expected the Fed to raise its benchmark federal-funds rate at its Dec. 15-16 policy meeting. Some 5% said the Fed would stay on hold until March and 3% predicted the Fed would keep rates at near-zero even longer.
From NY Fed President William Dudley sees the risks in liftoff as "balanced": The U.S. Economic Outlook and Monetary Policy
I see the risks right now of moving too quickly versus moving too slowly as nearly balanced. The weight that one puts on each undoubtedly influences one’s views on when the time will be right to begin to normalize monetary policy and the appropriate short-term rate trajectory thereafter.
Chicago Fed President Charles Evans argues for a later liftoff: A Cautious Approach to Monetary Policy Normalization
There is no doubt that labor markets have improved significantly over the past seven years. Job growth has been quite solid for some time now. That includes last month’s number, which was quite good. And today, at 5 percent, the unemployment rate is one half its peak in 2009. This is just a tenth of a percentage point above the median long-run projection. However, a number of other labor market indicators lead me to believe that there still remains some additional resource slack beyond what is indicated by the unemployment rate alone: Notably, 1) a large number of people who are employed part time would prefer a full-time job; 2) the labor force participation rate is quite low, even after accounting for demographic and other long-running trends; and 3) wage growth has been quite subdued. In sum, I don’t think we’re quite there yet, but we have made good progress toward meeting our employment mandate.
However, I am far less confident about reaching our inflation goal within a reasonable time frame. Inflation has been too low for too long. Core PCE inflation — which strips out the volatile energy and food components and is a good indicator of underlying inflation trends — has averaged just 1.4 percent over the past seven years. Core PCE inflation over the past 12 months was just 1.3 percent. And inflation according to the total PCE Price Index — which does include food and energy prices — was just 0.2 percent over the past year.

Most FOMC participants expect inflation to rise steadily from these low levels, coming in just a shade under the Committee’s 2 percent target by the end of 2017. My own forecast is less sanguine. I expect core PCE inflation to undershoot 2 percent by a greater margin over the next two years than do my colleagues. I expect core PCE inflation to be just below 2 percent at the end of 2018.
How does this asymmetric assessment of risks to achieving the dual mandate goals influence my view of the most appropriate path for monetary policy over the next three years? It leads me to conclude that 1) a later liftoff and 2) a more gradual normalization of our monetary policy setting will best position the economy for the potential challenges ahead.

More specifically, before raising rates, I would like to have more confidence than I do today that inflation is indeed beginning to head higher. Given the current low level of core inflation, some evidence of true upward momentum in actual inflation is critical to this assessment. I believe that it could be well into next year before the headwinds from lower energy prices and the stronger dollar dissipate enough so that we begin to see some sustained upward movement in core inflation. After liftoff, I think it would be appropriate to raise the target interest rate very gradually. This would give us sufficient time to assess how the economy is adjusting to higher rates and the progress we are making toward our policy goals.

Overall, my view of appropriate policy is somewhat more accommodative than those held by the majority of my colleagues.