The Federal Open Market Committee should not raise interest rates until the last half of 2016, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Tuesday.
"Under my current outlook, I continue to believe that it would be a mistake to raise the target range for the fed funds rate in 2015," said Kocherlakota, who doesn't hold a vote on the FOMC this year, said in a speech in Bismarck, N.D., according to prepared text released by the Fed.
"[B]ased on my current assessment of the future evolution of the economy, I anticipate that it would be appropriate for the FOMC to defer the initial interest rate increase until the second half of 2016," he said. "It would then be appropriate under my outlook for the FOMC to raise the target range for the fed funds rate thereafter to about 2 percentage points by the end of 2017. This would be slower than the last tightening of monetary policy in 2004 to 2006."
"The FOMC is charged with making monetary policy so as to promote maximum employment and price stability. There is no tension between these two objectives at the current time," he said. "I expect that it will take several years for employment to return to its maximal level. I expect that it will take several years for inflation to return to target. The FOMC can best facilitate its pursuit of both mandates by forgoing any near-term reduction in the level of monetary accommodation."
Kocherlakota believes in order for labor market conditions to return to their pre-recession levels, there must be three more years of 2014-like job growth. "It follows that monetary policymakers should be extraordinarily patient about reducing the level of monetary accommodation," he said.
It will be "several years" before the Fed accomplishes its dual mandate of price stability and full employment, he said.
2014 disproved the belief that the Great Recession caused a new dynamic in the labor force, as the dramatic improvement "is not consistent with an economy stuck in a post-recession new normal. The pessimists were wrong-and so the FOMC should be aiming to facilitate a continuation of the 2014 improvement in the labor market."
Using 2006 as the benchmark for full employment, Kocherlakota said, "we will need at least three more years as good as 2014" to reach that level.
"My own assessment is that the Committee will only be able to achieve this outcome by being extraordinarily patient about reducing the level of existing monetary accommodation. In particular, I don't see raising the target range for the fed funds rate above its current low level in 2015 as being consistent with the pursuit of the kind of labor market outcomes that we are charged with delivering," he added.
Inflation will remain below 2% until sometime in 2018, according to Kocherlakota's projections.
"Inflation is a variable that typically evolves slowly," he said. "It has been below 2 percent for a long time, and it is unlikely to move back to 2 percent rapidly. ... I don't see inflation returning to 2 percent in a sustained way for three years - possibly longer. And my perspective mirrors that of Federal Reserve Board staff. The minutes from the January FOMC meeting specifically state that the staff outlook is that inflation will remain below 2 percent through 2017."
Those who expect stronger inflation, he said, are probably using "the Phillips curve," which suggest that "as the unemployment rate falls, the growing scarcity of workers should push up on wages and prices. The unemployment rate has fallen steadily over the past few years, and it is thought by some that this decline should generate 2 percent inflation in the next year or two."
However, it is difficult to depend on the Phillips curve, since "for a number of reasons that we don't fully understand, the Phillips curve moves around a lot over time," Kocherlakota said.
