Why Clarida backs gradual rate hikes

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Monetary policy remains accommodative and gradual rate increases are likely to be needed, Federal Reserve Vice Chair Richard Clarida said Thursday in his first speech since being sworn in last month.

“If the data come in as I expect, I believe that some further gradual adjustment in the federal funds rate will be appropriate,” Clarida told an audience in D.C., according to prepared text released by the Fed. “I believe monetary policy today remains accommodative, and that, with the economy now operating at or close to mandate-consistent levels for inflation and unemployment, the risks that monetary policy must balance are now more symmetric and less skewed to the downside.”

Clarida did not specify how many hikes would be needed to reach a neutral level — one that neither stimulates nor restricts the economy — or if he thought rates would need to rise above a neutral level. He said he would use “a wide range of economic and financial market indicators” as well as “predictions yielded by model-based scenarios” to help him decide “the pace and ultimate destination for monetary policy adjustment.”

If the economy strength continues, job creation stays “robust” with “a material rise in actual and expected inflation, that circumstance would indicate to me that additional policy normalization might well be required beyond what I currently expect. By contrast, if strong growth and employment gains were to continue and be accompanied by stable inflation, inflation expectations, and expectations for Fed policy, that situation, to me, would argue against raising short-term interest rates by more than I currently expect.”

He called the Federal Open Market Committee’s decision to raise the federal funds rate target 25 basis points to a 2% to 2.25% range “another step in removing the extraordinary degree of accommodation put in place in the aftermath of the Global Financial Crisis,” one he agreed with.

He noted the importance of keeping real interest rates above the longer-run neutral real rate, or r-star, which is not yet the case. And while estimates of r-star are inexact, Clarida said, “I do not believe they should be ignored,” but rather regularly updated.

“Moreover, because monetary policy operates with a lag, and with inflation presently close to the 2 percent goal, it will be especially important to monitor inflation expectations closely — using both surveys and financial market data —to best calibrate the pace and destination for policy normalization.”

Clarida suggested both structural and cyclical factors may be responsible for gross domestic product growth and the “surprising” strength in the jobs market. “That said, based on my reading of the accumulating evidence, I believe that trend growth in the economy may well be faster and the structural rate of unemployment lower than I would have thought several years ago,” he noted. “This outlook for the labor market also reflects my view that the structural, or longer-run, rate of unemployment — that is, the unemployment rate consistent with stable inflation over the longer run — may be somewhat lower than I would have thought several years ago. What this means is that, even with today’s very low unemployment rate, the labor market might not be as tight — and inflationary pressures not as strong — as I once would have thought.”

Most FOMC participants, he noted, have cut their estimates for the long-run unemployment rate over the past several years, as have others. “This makes sense,” he said. “With unemployment falling and wage gains thus far in line with productivity and expected inflation, the traditional indicators of cost-push price pressure are not flashing red right now.”

With the economy “as near as it has been in a decade to meeting both of the Fed’s dual-mandate objectives,” Clarida said, it “suggests to me that monetary policy at this stage of the economic expansion should be aimed at sustaining growth and employment at levels consistent with keeping inflation at or close to the 2 percent rate consistent with price stability. By contrast, until this year, the appropriate focus of policy had been to return employment and inflation to levels consistent with our dual-mandate objectives. With the economy now operating at or close to mandate-consistent levels for inflation and unemployment, the risks that monetary policy must balance are now more symmetric and less skewed to the downside.”

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Monetary policy Richard Clarida Federal Reserve FOMC
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