Economic conditions should allow the Federal Open Market Committee to raise the fed funds target later this year Federal Reserve Bank of New York President and Chief Executive Officer William C. Dudley said Friday.
"I still think it is likely that conditions will be appropriate to begin monetary policy normalization later this year," Dudley told the Economic Club of Minnesota. "But the likelihood and timing will depend on the economic outlook, and that will be largely shaped by the incoming economic data."
While Dudley sees progress toward hitting its dual mandate, he said he has "become somewhat more uncertain about the growth outlook given the lack of a sharp rebound in economic activity in recent months from the weak first quarter."
It is the labor market outlook that will hold the key. As the labor market improves, he said he fears less that inflation will remain too low. "If the labor market continues to improve and inflation expectations remain well-anchored, then I would expect — in the absence of some dark cloud gathering over the growth outlook — to support a decision to begin normalizing monetary policy later this year."
Dudley emphasized the conflicts in the economy: "forward momentum has slowed sharply during the first half of the year and inflation remains below the level the Federal Open Market Committee (FOMC) views as consistent with price stability" yet he believes progress is being made toward accomplishing price stability and maximum employment.
The economy and productivity will both grow, although Dudley sees "some uncertainty" whether this will be strong enough to help jobs.
"With respect to inflation, as long as growth remains strong enough to lead to further improvement in labor market conditions — and this is an important caveat — I am becoming more confident that inflation will move up toward the FOMC's 2 percent objective over the medium term," he said. "The firming of inflation that I anticipate reflects my expectation that resource utilization will increase and the fact that some of the factors that have pulled down inflation, such as lower oil and gas prices and a firmer dollar, have already stabilized or partially reversed."
Noting that normalization will begin "in a very different environment than in the past, with the Fed's balance sheet so large, Dudley said it "should not adversely affect our ability to push the federal funds rate into a higher target range. We have the appropriate tools to push up short-term interest rates. However, lift-off may not go so smoothly in terms of the impact on financial asset prices. After all, lift-off will represent a regime shift after more than six years at the zero lower bound."
He expects short-term rates to take a "shallow, upward path" after liftoff, as "the level of real short-term interest rates consistent with a neutral monetary policy seems considerably lower now than in the past."
Slower GDP growth will also keep short-term rates down.
"But there must be considerable uncertainty about the path for short-term interest rates. After all, the economic outlook is uncertain," he said. "Moreover, the appropriate stance of monetary policy will be influenced by how financial market conditions respond to the Federal Reserve's actions. All else equal, if financial conditions tighten sharply, then we are likely to proceed more slowly. In contrast, if financial conditions were not to tighten at all or only very little, then — assuming the economic outlook hadn't changed significantly — we would likely have to move more quickly. In the end, we will adjust the policy stance to support the financial market conditions that we deem are most consistent with our employment and inflation objectives."
As for the GDP contraction in the first quarter, Dudley said the weather and "a sharp contraction in oil and gas investment, a deterioration in the trade balance due — in large part — to the stronger dollar and sluggish foreign demand, and a slowdown in consumer spending growth after a very strong fourth quarter" all contributed, and "seasonal adjustment issues" could have played a role.
Had it been just weather, a sharp second-quarter rebound would have been expected. "But current data suggests that the rebound has been relatively muted. I think this is because some of the non-weather factors evident in the first quarter — such as the drag from the sharp drop in oil and gas investment — have persisted into the second quarter."
Growth, he said, should "pick up further during the remainder of this year."
Of course, there are no guarantees, he said, "I can't be completely confident about this forecast. After all, several times during this expansion we have been fooled by sharp rises in the growth rate that appeared to presage a sustained pickup, but that subsequently proved fleeting."
