Rate hikes will probably be needed "sooner and at a faster pace" than the Federal Open Market Committee projects Federal Reserve Bank of Kansas City President and CEO Esther L. George said Tuesday.
"A gradual path for the federal funds rate is suggested by the FOMC's projections. However, in my view, it will likely be appropriate to raise the federal funds rate somewhat sooner and at a faster pace," George told business and community leaders in Colorado, according to prepared text released by the Fed.
George worries "that keeping rates very low into late 2016 will continue to incentivize financial markets and investors to reach for yield in an economy operating at full capacity, posing risks to achieving sustainable growth over the longer run."
While normal is a range, George said, "I think a return to more-normal economic conditions is on the horizon."
"As the economy returns to normal, the Federal Reserve's posture of extraordinary accommodation will need to shift to more-neutral settings," she added. "The timing and pace will have a significant influence on whether the economy experiences a hard or soft landing."
Further, George warned, the road is not familiar. "Efforts by the central bank over the past five years have been unprecedented, and its process of normalization is likely, in many respects, to lack familiar rhythms," she said.
Even the preparation for the first rate hike will be parsed. While the steps were laid out in 2011, much needs to be determined, although "the FOMC reviewed this plan last year and considered the 2011 principles broadly as still applicable. However, the FOMC has noted that when it becomes appropriate to normalize monetary policy, the details of the process would depend in part on economic and financial developments and that it would communicate its intentions as that time approaches."
Still, the fed must determine "in the relatively near future," how to reduce its balance sheet after it stops buying assets. George suggested using "passive runoff," not reinvesting maturing securities, prior to the first rate hike. "As the outlook improves, this modest step would begin the normalization process and is in line with the 2011 principles."
Tightening monetary policy can be "difficult," and in the past there are times when the decision "came too late." It becomes more complex when "the signals of sustainable growth are not entirely clear cut."
Normalization will take "a great deal more" courage in terms of policy and politics, than easing did, she said. "Accordingly, sending the appropriate signals and communicating is clearly important so that tightening policy is not a surprise. One current issue is that even as the economy moves back toward more-normal conditions, the FOMC has signaled that monetary policy is still some time away from normalizing."
FOMC projections see the fed funds rate at the end of 2016 still below its long-term level, despite "normalized" economic conditions, although George said she believes "the economy could be there a bit sooner."
While there are those who are concerned headwinds could linger into 2016, she said, "I think it is hard to see such persistent headwinds still weighing on the economy two years from now, unless some new shock causes economic activity to slow."
"As the headwinds weighing on the recovery thus far start to fade, policy may need to react sooner than what is suggested in the FOMC's projections," George said. "However, once policy normalization begins, a gradual rise in the federal funds rate toward its longer-run level will be important and promote financial stability. Steady moves are more predictable and reduce the chance of unexpected shifts in longer-term interest rates."
While she predicts the economy will grow this year at the same pace as last year, "the factors driving it will be different and point to surer footing."
