Monetary policy should be based on fundamentals and should not overreact to financial market volatility, according to Federal Reserve Bank of Kansas City President and Chief Executive Officer Esther L. George, and conditions should warrant further rate hikes.
"Even looking at developments so far this year, financial markets have been quite volatile," George said in a speech at the Central Exchange, according to prepared text released by the Fed. "While taking a signal from such volatility is warranted, monetary policy cannot respond to every blip in financial markets. Instead, a focus on economic fundamentals, such as labor markets and inflation, can help guard against monetary policy over- or underreacting to swings in financial conditions."
Indeed, she noted the caution by the Federal Open Market Committee in taking a gradual approach to raising rates to "avoid unnecessarily jolting the economy or causing excessive financial market volatility."
But, the recent volatility should have been expected after the first rate hike, and is not "necessarily worrisome, given that the Fed's low interest rate and bond buying policies focused on boosting asset prices as a means of stimulating the real economy. As asset prices adjust to the shift in monetary policy, it is to be expected that the pricing of risk will realign to this different rate environment," she said.
And, policy is still quite accommodative, she noted.
George said she believes economic growth, labor market improvement and "modestly higher core rates of inflation will warrant further increases."
As a result of monetary policy lags, "decisions must necessarily rely on forecasts and their associated risks — not waiting until desired objectives are realized," she said. "If we wait for the data to provide complete confirmation before making a policy decision, we may well have waited too long."
If data suggest otherwise, the FOMC can consider "altering its trajectory."
Absent a "substantial shift in the outlook," George said, "my view is that the Committee should continue the gradual adjustment of moving rates higher to keep them aligned with economic activity and inflation. These actions are often difficult, but also necessary to keep growth in line with the economy's long-run potential and to foster price stability."
The economy remains "in a generally good position," despite a few possible headwinds.
The energy sector, manufacturing and global growth all pose risks to the outlook, she noted.
