The Federal Open Market Committee should raise rates very gradually, and Federal Reserve Bank of Chicago President and Chief Executive Officer Charles L. Evans said Thursday he'd like the FOMC to follow the most accommodative path on the Summary of Economic Projections' "dot plot."
"Overall, I think appropriate policy is consistent with some of the most accommodative dots on the chart," Evans said at the Wisconsin Economic Forecast Luncheon, according to prepared text released by the Fed.
The neutral level for the federal funds rate is below the long-run normal as a result of the financial crisis and headwinds from abroad, he said. "By some estimates, the equilibrium inflation-adjusted rate is currently near zero. This rate should rise gradually as the headwinds fade over time. But until they do, monetary policy rates must be even lower than they otherwise would be to provide adequate accommodation for economic growth."
Low inflation rates also hold monetary policy levels down. Personal consumption expenditures has averaged 1.5% over the past eight years, "with the latest reading at just 0.4%," and core inflation "has been just 1.3% over the past 12 months," Evans noted.
Lower energy prices and a stronger dollar have partially accounted for the low levels, and Evans expects these "to dissipate as we move through the year. Further improvements in labor markets and growth in economic activity should also boost inflation. And so I see inflation moving up gradually to approach our 2 percent inflation target within the next three years."
But, he noted, downside risks include continued "declines in energy prices or greater appreciation of the dollar."
Having missed the 2% inflation target for so long "invites the risk of the public beginning to expect persistently low inflation in the future," Evans said. "If this mindset becomes embedded in decisions regarding wages and prices, then getting inflation back to 2 percent will be that much more difficult. Here, I find it troubling that the compensation for prospective inflation built into a number of financial market asset prices has drifted down considerably over the past two years. More recently, some survey-based measures of inflation expectations, which had previously seemed unmovable, have also edged down. So to achieve our inflation target — and to provide a buffer against downside risks — it is appropriate that we follow a gradual path to policy normalization."
Evans admitted he is "less optimistic about the inflation outlook than most of my colleagues," and therefore favors a "very gradual policy normalization to help ensure that we meet our inflation goal within a reasonable amount of time. Moreover, as I have argued many times, prudent risk management calls for a slower removal of accommodative monetary policy. From my perspective, the costs of raising the federal funds rate too quickly far exceed the costs of removing accommodation too slowly."
As a result, he believes "policy should plan to follow an even shallower path for the federal funds rate than currently envisioned by the median FOMC participant."
Evans noted, "there is no single, predetermined rate path that is consistent with a gradual approach," and policy will be determined with the assistance of incoming data.
In terms of the labor market, Evans sees "some additional resource slack beyond what is indicated by the unemployment rate alone. So I don't think we have quite met our employment mandate. But we certainly have made great progress toward meeting that goal."
The economy should grow 2% to 2.5% this year, Evans predicted, "close to or a bit better than this past year." But, he noted, "I was struck by the realization that in each of the past six years I began with an optimistic view of how fast the economy was going to grow — only to be disappointed with the numbers coming in below my projections."
