Since future rate decisions will be based on data, the next move by the Federal Reserve will be up if inflation gains momentum, and down if activity softens too much or inflation cools further, Federal Reserve Bank of Chicago President Charles Evans said Monday.
“If growth runs close to or somewhat above its potential and inflation builds momentum, then some further rate increases may be appropriate over time to ensure that the economy settles in on its long-run sustainable growth path and that inflation runs symmetrically about our 2% target,” Evans told the New York Association of Business Economists, according to prepared text released by the Fed. “Frankly, though, given how muted inflationary pressures appear today, a rise to 2-1/4 to 2-1/2% is not a big concern to me at the moment.”
But, he added, “if activity softens more than expected or if inflation and inflation expectations run too low, then policy may have to be left on hold — or perhaps even loosened — to provide the appropriate accommodation to obtain our objectives.”
In earlier comments on CNBC Monday, Evans said the Fed could probably leave rates where they are (2.25%-2.5%) until the fall of 2020.
Several downside risks to economic growth arose late in 2018, including slowing foreign growth, a possible “disorderly Brexit” and uncertainty over trade negotiations. “These issues generated quite a bit of volatility in financial markets beginning last October,” he said. “Investors appear to be calmer today, and some financial indicators have improved noticeably. Still, on net, the market spasms have left us with effectively tighter overall financial conditions than we had last autumn, providing less support to real economic activity. Indeed, the latest data point to appreciably slower momentum so far this year in consumer spending, housing and business investment.”
The government shutdown, which delayed release of many economic indicators, making it “difficult to discern if the recent weak readings are a temporary pothole or a more sustained soft patch.”
While the general expectation was for slower growth in 2019, Evans said, he expects a 1.75% to 2% rise in GDP this year, off from the 2.25% he projected in the fall. “Now, the lower end of this range is actually in line with my view of the economy’s long-run growth potential,” he said. “So we’re not looking at bad numbers; still, the economy won’t feel like it is doing very well compared with last year’s very strong performance.”
Turning to inflation, he noted, “there are important costs to downside misses” to the Fed’s 2% inflation target. “I am concerned about this today because over the past ten years actual inflation has consistently underrun our target, and these misses appear to have caused inflation expectations to fall below levels consistent with our 2% goal. A low neutral real interest rate combined with low inflation expectations means nominal interest rates are low. This increases the odds of a negative shock driving policy rates to the [zero lower bound], where we can no longer use traditional monetary policy tools to battle low growth and disinflationary pressures.”
The Chicago Fed will host a monetary policy strategy conference in June. Evans said the Fed will consider “alternative monetary policy strategies that could generate better macroeconomic outcomes in a world in which the zero lower bound remains a more obstinate risk.”
Two such alternates — price level targeting and inflation averaging — in theory “can deliver very good macroeconomic outcomes in the presence of the zero lower bound.” But to work, the public needs to believe the Fed “can deliver periods of above-target inflation following episodes at the ZLB — and that it will follow through on doing so.”
To cure the problem of inflation expectations remaining below 2%, Evans said, “I think the Fed must be willing to embrace inflation modestly above 2% 50% of the time. Indeed, I would communicate comfort with core inflation rates of 2-1/2%, as long as there is no obvious upward momentum and the path back toward 2% can be well managed.”
Words will not be enough, he noted, and should be backed by “actions and … policies consistent with these communications.”
