A rate hike should be appropriate “in the near future,” Federal Reserve Bank of Dallas President Rob Kaplan, a Federal Open Market Committee voter this year, wrote in an essay released by the Fed Monday.

Federal Reserve Bank of Dallas President Rob Kaplan.
Federal Reserve Bank of Dallas President Rob Kaplan. Bloomberg News

The markets have penciled in a December rate hike.

“I believe it will likely be appropriate, in the near future, to take the next step in the process of removing monetary accommodation,” Kaplan wrote. “This should be done in the context of an overall strategy of removing accommodation in a gradual and patient manner. I believe this strategy will increase the likelihood of sustaining and extending the economic expansion in the U.S.”

The neutral rate is around 2.5%, he estimated, “materially lower than we are historically accustomed.” As a result, the FOMC should remove monetary policy accommodation “in a gradual and patient manner,” so avoid falling behind the curve and then needing to catch up by raising rates.

“I am also mindful that if we wait too long to see actual evidence of inflation, we may get behind the curve and have to subsequently raise rates more rapidly,” he said. “This type of rapid rate rise has the potential to increase the risk of recession.”

Labor market participation is down, but the Dallas Fed believes “a majority of the decline in participation is due to the aging of the population,” and the U.S. “is at or near full employment.” And the workforce will continue to age, and the labor participation rate will decline.

“Because GDP growth is comprised of growth in the workforce plus gains in labor productivity, weaker expected workforce growth is likely to negatively affect potential GDP growth in the years ahead — unless steps are taken to mitigate these effects,” Kaplan wrote.

Turning to inflation, Kaplan wrote, cyclical inflationary pressures are building and should become more apparent over time, but for now they are at least partially offset by technology and globalization.

With these goals in conflict — the labor market appearing ready to overheat while inflation remains below target — policymakers use a “balanced approach” and assess other factors, including the size of the deviations and “the timing of expected return to mandated and/or sustainable levels.”

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