After having among the most accommodative assumptions on the Federal Open Market Committee, Federal Reserve Bank of Chicago President and Chief Executive Officer Charles L. Evans said Wednesday he is “comfortable” with the projections in the latest Summary of Economic Projections.
“My fed funds rate assumptions used to be some of the most accommodative ones on the FOMC. Today, with the latest changes in the Committee’s well-known ‘dot plot,’ I am comfortable with the path for the federal funds rate projected by the median FOMC participant in the March Summary of Economic Projections (SEP),” Evans told the Forecasters Club of New York, according to prepared text released by the Fed.
The “dot plot” predicts two rate hikes this year and 100 basis points of tightening in each of the next two years (four hikes each year if they’re 25 basis points each). Evans said that pace “certainly is a gradual path,” slower than the 2004-2006 tightening cycle that averaged 200 basis points a year.
Evans said, “I think a very shallow funds rate path, such as the one envisioned by the median FOMC participant, is appropriate.”
Above-potential growth and reduced unemployment levels are based in the boost to the economy from the gradual tightening, and with deleting accommodation quicker, the economy would suffer, he said.
Also, Evans said, the FOMC must be concerned that inflation expectations shouldn’t fall. “If the public doesn’t believe policymakers are trying to hit a symmetric 2 percent inflation target, it will be all that much harder to reach that policy goal. To convince them of this, appropriate policy should provide enough accommodation to generate a reasonable likelihood that inflation in the future could moderately exceed 2 percent.”
The neutral level of the feds fund rate is lower than its long-run level, Evans said. “By some estimates, the equilibrium inflation-adjusted rate is currently near zero. The degree of accommodation in actual policy needs to be judged against this benchmark. So the 75 to 100 basis point range for the nominal fed funds rate in the median SEP forecast for the end of 2016 is not terribly far below neutral,” he said.
Evans warned against raising rates too quickly and then be forced to cut rates due to a downside surprise. He also warned the FOMC needs to watch for “upside surprises in growth and inflation” during normalization.
“Well, we should buy some insurance against unexpected weakness by accepting a somewhat higher likelihood of stronger outcomes,” he said. “Translated into monetary policy, this means being more accommodative than usual to provide an extra boost to aggregate demand as a buffer against possible future downside shocks that might otherwise drive us back to the effective lower bound. “
In his view, the risks are “skewed in the direction of output running somewhat softer and inflation somewhat lower than what I have written down in my baseline projection. This tilting of the odds strengthens the rationale for shading policy in the direction of accommodation and provides additional support for a gradual path in normalizing policy.”
GDP should grow 2% to 2.5% this year, with consumer spending driving the increase, and the unemployment rate should fall to 4.5% to 4.75% by yearend, he predicted.
Inflation should also move toward 2% within three years. This year, Evans expects core inflation of 1.6%, near the 1.7% year-over-year pace from recent months.
“However, I am a bit uneasy about this forecast,” he said. “It is too early to tell whether the recent firmer readings in the inflation data will last or prove to be temporary volatility and reverse in coming months. We saw this happen in 2012. And there are some other downside risks to consider.”
Among the risks Evans mentioned were further oil price declines or more gains in the dollar. “Most worrisome to me is the risk that inflation expectations might drift lower.”
