If the economy grows as expected, further rate hikes will be necessary, although they should be gradual, not one every Federal Open Market Committee meeting, Federal Reserve Bank of Cleveland President and CEO Loretta J. Mester said Monday.
“Given my outlook, I don’t believe that removing accommodation calls for an increase in the fed funds rate at each meeting, but I do anticipate more than the one-increase-per-year seen in the past two years,” Mester told the Chicago Council on Global Affairs, according to prepared text released by the Fed. “In addition, I think that it’s important for the FOMC to remain very vigilant against falling behind as we continue to make progress on our goals, especially given the low level of interest rates and the large size of our balance sheet.”
Because monetary policy works “with long and variable lags,” action is needed goals are fully met, she said. Waiting too long, could lead to “a situation where the labor market becomes unsustainably tight, price pressures become excessive, and we have to move rates up steeply, we could risk a recession. This is a bad outcome that disproportionately harms the more vulnerable parts of our society.”
Also, the FOMC must act to normalize the Fed’s balance sheet, she said. While the FOMC discusses “when and how best to implement a change in reinvestments,” Mester suggested it should be gradual and predictable.
“In my view, if economic conditions evolve as I anticipate, I would be comfortable changing our reinvestment policy this year, with clear communication in advance about how we plan to implement the change,” she said. “My preference is that once we decide on a plan, we stay with it; the fed funds rate should be our main tool for responding to changes in the outlook during normal times.”
The run-off of assets can start before the FOMC chooses “the ultimate size of the balance sheet” since the process of reducing the balance sheet will take “several years.”
Mester wrote off weakness in the first quarter GDP, noting, “there are reasons to think this was a transitory slowdown. We’ve seen a pattern over the past several years of weak growth in the first quarter followed by stronger growth in subsequent quarters.”
