Market expectations of one 25 basis point increase in the fed funds rate target in each of the next three years does not reflect the fact the economy is “fundamentally sound” and is “inconsistent” with other projections, Federal Reserve Bank of Boston President and Chief Executive Officer Eric S. Rosengren said late Monday.
“While I believe that gradual federal funds rate increases are absolutely appropriate, I do not see that the risks are so elevated, nor the outlook so pessimistic, as to justify the exceptionally shallow interest rate path currently reflected in financial futures markets,” Rosengren said according to prepared text of his remarks at Central Connecticut State University, released by the Fed.
While the U.S. economy has shown “gradual improvement … global financial markets have been quite turbulent,” he said. Fear that economic problems abroad could affect the U.S., has weighed on projections for the U.S.
Contrasting expectations with the previous two tightening cycles, Rosengren noted, after its first increase in 2004, the Fed raise rates 25 basis points at every meeting for two years, which was slower than the pace of increases in 1994.
“Furthermore, I would point out that the extremely shallow rate path reflected in the market for federal funds futures seems at odds with forecasts by private sector economists and by financial firms that serve as counterparties to the Federal Reserve (the so-called primary dealers), as well as my own forecast for the U.S. economy,” he said. “Most of these forecasts envision a much healthier U.S. economy than is implied by that unusually shallow path of the funds rate, and many of the major private forecasters expect short-term rates to rise more rapidly than implied by financial futures.”
The latest Summary of Economic Projections, which suggested two rate hikes this year, “is consistent with my own estimate,” Rosengren noted.
The consequence of just one rate hike a year for three years, he said, could be pushing the unemployment rate “below the natural rate,” which “could be risky, as an overheating economy would eventually produce inflation rising above our 2 percent goal, eventually necessitating a rapid removal of monetary policy accommodation. I would prefer that the Federal Reserve not risk making the mistake of significantly overshooting the full employment level, resulting in the need to rapidly raise interest rates – with potentially disruptive effects and an increased risk of a recession.”
