After the next rate hike, the Federal Reserve should consider “a very gradual normalization” of its balance sheet, Federal Reserve Bank of Boston President and CEO Eric S. Rosengren said Wednesday.

Federal Reserve Bank of Boston President and CEO Eric S. Rosengren.
Federal Reserve Bank of Boston President and CEO Eric S. Rosengren. Bloomberg News

“Looking ahead, the federal funds rate would obviously exceed 1 percent after one more 25 basis-point increase. In my view, that seems an appropriate point to consider beginning a very gradual normalization of the Federal Reserve’s balance sheet,” Rosengren said in a Vermont speech, according to prepared text released by the Fed. “I believe the Fed should do so gradually, so that the reduction in the balance sheet is not disruptive, and so that it can occur largely in the background. This would maintain the Federal Reserve’s focus on the federal funds rate as the primary instrument of monetary policy.”

In addition to beginning reducing the balance sheet, Rosengren said, three more rate hikes in 2017 remain a “reasonable” expectation, should the economy proceed as expected.

First quarter weakness in GDP is not “a harbinger of softness in the underlying economy,” and GDP growth is “likely to exceed 2 percent” the rest of the year, he said.

Downside risks, including slow loan growth and weak economies abroad, “do not seem to me compelling reasons to slow down the gradual normalization of monetary policy,” he said.

“[I]t is important to avoid creating an over-hot economy (one that could require a less gradual monetary policy adjustment). And in order to avoid doing so, the Federal Reserve should continue gradually normalizing monetary policy,” he added. “This would imply beginning a very gradual reduction of securities held on the Federal Reserve’s balance sheet relatively soon, while continuing to use short-term interest rates as the primary monetary policy tool for maintaining sustainable growth – growth that is consistent with the Fed’s dual mandate of maximum sustainable employment and stable prices.”

Monetary policy, despite the three rate hikes already completed, “remains quite accommodative,” and with short-term nominal interest rates below the inflation rate, real interest rate remains negative, Rosengren said.

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