The Federal Reserve may need to raise interest rates to “somewhat restrictive” levels over the next couple of years to combat the effects of recent fiscal stimulus on the U.S. economy, Chicago Fed President Charles Evans said.

“If inflation continues to be on the order of 2, 2.2 (percent) — I’m not expecting it to get as high as 2.5 — that suggests only a modest amount of restrictiveness above our neutral rate might be called for in 2020,” Evans told reporters Thursday in Chicago.

Federal Reserve Bank of Chicago President Charles Evans.
Federal Reserve Bank of Chicago President Charles Evans. Bloomberg News

“It would not surprise me at all if we make a judgment to move to a somewhat restrictive setting,” he said, citing roughly half a percentage point above his 2.75% estimate of the neutral level of the federal funds rate.

For Evans, who has long been considered one of the most dovish officials at the U.S. central bank, the view that restrictive policy may be appropriate in the coming years marks a shift in his thinking. As recently as December, he dissented against rate increases on the grounds that inflation expectations were too low and may prevent inflation from rising to the Fed’s 2% target.

Now, given the boost to economic growth that tax cuts and government spending increases passed by U.S. President Donald Trump and the Republican-controlled Congress are expected to bring, Evans is more confident in the inflation outlook. A U.S. inflation gauge watched closely by central bankers, based on the prices of personal consumption expenditures excluding food and energy, was 1.9% in June, up from 1.6% a year earlier.

“I do think that the underlying inflation expectations that sort of underpin the current inflationary environment are a little bit lower than I would like to see,” Evans said. “Given the data — economy being strong — I think inflation expectations are going to catch up.”

Evans sees a need for restrictive interest-rate policy in the coming years because he expects unemployment to fall to around 3.5% by the end of 2020. It was 3.9% in July. The Chicago Fed’s estimate of the so-called natural rate of unemployment — the rate that policy makers believe would be sustainable in the long run without causing inflation to rise — is 4.3%.

But he cautioned that uncertainty about the natural rate of unemployment is very large, as much as “two percentage points on either side.”

The tariffs recently imposed on Chinese imports by the Trump administration seem to be “adding some uncertainty, but it’s uncertainty at a time where the economy is doing very strongly, and the labor market continues to improve,” so it makes sense to continue raising interest rates, he said.

Trump recently criticized the Fed’s rate increases, saying he doesn’t “like all of this work that we’re putting into the economy and then I see rates going up.”

When asked about Trump’s comments, Evans said he wasn’t concerned.

“I take a lot of confidence from the way that the Federal Reserve system has been designed by Congress and the president, that we have a certain amount of independence, that we’re allowed to undertake our best decision-making," he said.

Bloomberg News