While he agrees to gradual removal of monetary policy accommodation, and a 2.8% landing point for the federal funds rate, Federal Reserve Bank of Chicago President Charles Evans said Wednesday he would wait before raising rates again.
“With the data I see today, my policy strategy would be to keep policy on hold until midyear or so in order to assess the incoming inflation data,” Evans told the Iowa Bankers Association, according to prepared text released by the Fed. “If we get to that point and have more confidence that inflation is moving up sustainably, then further rate increases would be warranted.”
If inflation picks up, he noted, the Fed would still have the opportunity to “easily raise rates another three or even four times in 2018 if that were necessary. And I would support such a faster pace if the data point convincingly in this direction.”
The Federal Open Market Committee has experience dealing with faster-than-expected increases in inflation, he said, “That’s an issue the FOMC knows how to fix. We would respond by increasing the federal funds rate more quickly.”
Economic performance was “solid” last year, with gross domestic product rising 2.5%, strengthening after a weak first quarter, with consumer spending “quite robust.”
Businesses increased equipment spending, as “orders for capital goods and other related indicators remain quite strong, so clearly there is a good deal of forward momentum to capital spending as we enter 2018.”
Regarding tax reform, Evans noted, “It is difficult to determine how households and firms will respond to the provisions in the bill, which could influence economic activity through a variety of channels.”
The Beige Book, he said, “indicated that, on average, about a quarter of the tax savings is expected to go toward capital spending and about 15 percent to labor. Most of the remaining 60 percent is planned to be used to pay down debt, fund mergers and acquisitions, and return funds to shareholders.”
How this affects GDP, he said, “is highly uncertain. Still, by most analyses, the act should boost aggregate activity in the near and medium terms. The estimates for 2018 generally range between 0.4 and 0.8 percent.”
“When I sum everything up, I expect GDP growth in 2018 to be in the 2-1/2 to 2-3/4 percent range,” Evans said. “For the following two years, I anticipate growth to slow down some, as the tax cut bump wears off. These gains should be benchmarked against the underlying trend in GDP growth, which my staff estimates will be between 1-3/4 to 2 percent over the next few years.”
This should push the unemployment rate down to “about 3.5% by the end of 2020,” a percentage point below the Chicago Fed’s estimate of the natural rate.
“I expect inflation to rise gradually over the next few years,” Evans said. “If my forecast for the drop in the unemployment rate is correct, then we should see some pressures developing on productive resources in the economy, generating higher costs and higher prices.”
Inflation should hit the Fed’s 2% target “in late 2019 or in 2020,” he estimated. “I have not yet seen many actual increases in consumer prices. So, my forecast of reaching our target is still just a forecast. There is still a role for accommodative monetary policy to bring us back to our 2 percent inflation target.”
Evans said he fears it’s more than just transitory factors keeping inflation low, which is why he dissented on the December rate hike. “In particular, I am concerned that the public’s inflation expectations may have drifted down below the FOMC’s symmetric 2 percent inflation target.”
Also, he fears “too many observers have the impression that the FOMC’s 2 percent objective is a ceiling that policymakers do not want to breach. This belief would then cause them to think inflation over the long run would average somewhere below 2 percent.”