WASHINGTON — Kansas City Federal Reserve Bank President Esther George Tuesday lauded the "steady" improvement that she is seeing in the jobs market, and said if the unemployment rate falls as expected, the Fed should begin slowing the pace of its bond buying in September and end the program during the first half of next year.
In a speech to open a Kansas City Fed Agricultural Symposium, George went on to say that the pace of the tapering should be faster if economic conditions improve faster than currently forecast. She also said the Fed should begin hiking interest rates once the unemployment rate falls below 6.5%.
George is voting member of the Fed's policymaking Federal Open Market Committee, a dissenter at every meeting this year who acknowledged in her remarks that her views "have differed" from the majority of the group regarding the Fed's unconventional policies.
Following the last FOMC meeting in June, Fed Chairman Ben Bernanke announced that — based on its forecasts — the FOMC expects to begin scaling back the $85 billion a month in asset purchases later this year, and then end the program by mid-2014 — when it sees the unemployment rate falling to 7%.
George said that, "Specifically, I would like to see the FOMC begin to systemically reduce the pace of purchases in manner that brings the program to an end sometime during the first half of next year."
"The economy is positioned, in my view, to benefit from modestly higher, longer-term interest rates," she added, such as the boost for savers, and banks' net-interest margins without having to take on more risk.
"If the unemployment rate falls as expected, and inflation moves toward the 2% (FOMC) goal, then reducing the pace of purchases in September and ending them next year is appropriate," she said.
On the other hand, "The committee's forecasts have often been too pessimistic about the unemployment rate, that is the unemployment rate has generally fallen faster than we've expected. If this were to occur in the context of a firmer inflation outlook, then it may be appropriate to reduce the pace of purchases more quickly than I've suggested," George added.
George noted financial markets are already adjusting to the reality that the Fed's aggressive support for the recovery cannot last indefinitely. She stressed, however, that even when reducing the pace of asset purchases, the Fed continues to add accommodation.
Citing the more optimistic forecasts of FOMC participants for unemployment, George said the smaller difference in forecasts compared to last September "suggests that members of the FOMC are in closer agreement about the improved outlook for the labor market."
The FOMC has also said it expects short term interest rates to remain near zero long as unemployment remains above 6.5% and inflation does not threaten to exceed 2.5%. George disagrees with the manner in which these thresholds are currently utilized by the FOMC.
"My own view is that these thresholds should act similar to triggers," George argued, "so once the employment rates 6.5%, markets and the public should expect lift-off of short-term interest rates."
Thresholds have the potential to perpetuate uncertainty about when rates will increase she said. On other hand the trigger is more of a rule and can provide "firmer guidance and certainty, in my view, to the public and markets about when rates are likely to first increase."
Despite occasional setbacks, George said, namely from events abroad — but also a U.S. fiscal policy that is "now weighing on current growth" — the economy has continued to heal, with signs of steady progress in a number of areas.
In particular, both the housing and labor markets are now showing "more convincing signs that, in my view, we are on a steady and sustainable growth path," George declared.
Employment has increased by slightly more than 200,000 a month for the past six months, she noted, while measures of labor market slack have been steadily declining since 2010.
"An especially good sign, I think, is that the recovery in the labor market has breadth as far as industries continue to add jobs that are reducing unemployment," she continued, "so this broad base of hiring is quite reassuring."
On the housing front, rising prices are helping to repair household balance sheets, George said. The housing rebound is is also likely to boost hiring, and increased activity will have knock-on effects by boosting services related to the housing industry.
In spite of the above positive trends, George warned that the economy's rate of growth this year will be tempered by fiscal tightening — 1.5 percentage points of 2013 GDP, and the struggles of key trading partners such as the Eurozone.
"With these headwinds I anticipate real GDP growth this year is going to be somewhere around 2%, driven largely by the improvements in the labor markets and in housing," she said.
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