With little slack in the labor market, “inflation is likely to reassert itself at some point, so increasing the fed funds target rate “makes sense,” Federal Reserve Bank of Philadelphia President Patrick Harker said Sunday.
“From my perspective, removing accommodation is the right next step for a few reasons,” Harker said in a speech in Tokyo, according to prepared text released by the Fed. Among the reasons he cited: an economy “more or less at full strength”; nearly a decade of accommodative monetary policy; and growth on pace with projections.
“Inflation is still below the Fed’s target rate and is the one area that not only continues to elicit caution,” he said, “it even constitutes a conundrum.”
The Fed must be cautious “about how we’re measuring inflation,” he noted, arguing “the Phillips curve has not been a good predictor of inflation” for “several decades.”
Additionally, he noted, raising rates will be a safety measure in case of a shock. “I want our tools to be at their most effective and, in my view, that means reducing our balance sheet. Additionally, as productivity has dropped, it’s taken the neutral funds rate with it, making the zero lower bound closer and resulting in less room for maneuver with the funds rate, which will continue to be our primary monetary policy tool.”
“The famous line is that the Fed takes away the punch bowl just as the party is getting good,” Harker said. “I don’t think we’re taking away the bowl; I think we’re making sure there’s enough punch for the future.”
When the decision to normalize the balance sheet was made, he said, the Fed wanted a “slow, steady pace,” but “[w]e also knew, from past experience, that communicating our intentions was going to be a key factor in the efforts.”
By choosing to stop reinvesting maturing securities, rather than selling on the open market, Harker said, it “ensures the crucial aspects of gradual, predictable, and boring that we’re aiming for.” But, he added, the Fed will monitor the situation and revisit it if events warrant a change.
“I’ve said before that this will be the policy equivalent of watching paint dry,” he said. “But I should specify that the paint is oil based; the process is going to take some time. We have not yet established what the new normal will look like.”
As has been said, the balance sheet will not revert to its pre-crisis level since the economy has grown. “But its eventual size will depend on how overnight and other short-term rates behave as the unwinding progresses.”