The Federal Open Market Committee must be confident inflation will rise to the 2% target before raising interest rates again, Gov. Lael Brainard said Tuesday.

“Once balance sheet normalization is under way, I will be looking closely at the evolution of inflation before making a determination about further adjustments to the federal funds rate,” Brainard told the Economic Club of New York, according to text of her remarks, released by the Fed. “We have been falling short of our inflation objective not just in the past year, but over a longer period as well. My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target. Unless we expect inflation to move quickly back toward target — or there are indications that the short-run neutral rate has moved up further — a variety of empirical estimates suggest we could approach neutral without too many additional rate increases. Many forecasters assume that the neutral rate of interest is very low currently, and that it is likely to be low relative to historical norms in the longer run.”

Federal Reserve Board Governor Lael Brainard.
Federal Reserve Board Governor Lael Brainard. Bloomberg News

Foreign central banks continue buying longer-term assets, which she said, “will likely continue to hold down U.S. longer-term interest rates. But with economies abroad strengthening, it may not be too long before some foreign central banks will end their net purchases and, eventually, begin reducing their balance sheets.”

When the stop the purchases, it will reduce downward pressure on longer-term rates. “For these reasons, my current expectation is that the short-run neutral rate of interest may not rise much over the medium term. But this is an open question and bears close monitoring,” Brainard said.

And, she said she “would be comfortable with inflation moving modestly above our target for a time.”

However, Brainard warned, the Fed must watch for signs of bubbles, mentioning commercial real estate and corporate bonds. “Nonetheless, there are few signs of a dangerous buildup of leverage or of maturity transformation, which have traditionally been important contributors to financial instability.”

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Gary Siegel

Gary Siegel

Gary Siegel has been at The Bond Buyer since 1989, currently covering economic indicators and the Federal Reserve system.