WASHINGTON — U.S. tax reform strengthened Federal Reserve officials' outlook for economic growth and the labor market as they expect tax cuts to give some boost to consumer and business spending, minutes of the Federal Open Market Committee's December meeting showed Wednesday.
All but a couple of FOMC members thought it appropriate to raise interest rates to a 1.25% to 1.50% range on Dec. 13, underscoring strong support for the move among both voters and nonvoters. Two dissenters, Charles Evans and Neel Kashkari, respectively of the Chicago Fed and Minneapolis Fed banks, cited below-target inflation as reason to wait.
"Most participants reiterated their support for continuing a gradual approach to raising the target range," the minutes said, "noting that this approach helped to balance risks to the outlook for economic activity and inflation."
Among the upside risks, inflation pressures could "build unduly" if output expanded "well beyond its maximum sustainable level, perhaps owing to fiscal stimulus or accommodative financial market conditions," the minutes said. However, on the other hand, a failure of inflation to move toward the Fed's 2% target could lead to a slower pace of rate hikes than projected, the committee said.
For now, the FOMC said it generally viewed the medium term outlook for inflation as "little changed." It expects to raise rates three times in 2018 and two times each in 2019 and 2020.
Many officials expected cuts in business taxes to provide a "modest boost" to capital spending, "although the magnitude of the effects was uncertain," the minutes said. That boost could generate positive supply-side effects, raising potential output over the next few years.
However, officials noted that some responses from business contacts suggested that firms were cautious about expanding capital spending in response to the tax changes or noted that any increase in cash flow was more likely to be used for mergers and acquisitions or to pay off debt and buy back stock.
Meanwhile, lower individual tax rates should could draw more folks to the job market as well as bolster consumer spending, which had already been growing moderately on account of the strong labor market, improving household net worth and buoyant consumer sentiment, Fed officials said. But again, the extent of the potential effects were uncertain, with a few officials noting expectations of tax reform may have already raised consumer spending somewhat.
Officials continued to expect inflation to return gradually to their 2% target as transitory factors begin to fade out of calculations. But several FOMC members noted that survey-based measures of inflation expectations or market-based measures of inflation compensation remained low or that other persistent factors may be holding down inflation, "which would present challenges for the Committee in promoting a return of inflation to 2 percent over the medium term."
Leaving the target range at 1% to 1.25% "for a time" would better support an increase in inflation expectations and increase the likelihood that inflation will rise to 2%, Evans noted in explaining his dissenting vote.
A flattening of the yield curve in November and December set off a discussion among FOMC members, who agreed that the current degree of flatness was "not unusual by historical standards."
Some officials expressed concern that a possible inversion of the yield curve in the future could portent a recession or adversely affect the health of banks and other financial institutions, however a couple others argued an inversion might not necessarily foreshadow a downturn as it is an expected consequence of the Fed's rate increases.
