Why Evans thinks rates will eventually go above neutral

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The first six months of 2019 will play a big role in future monetary policy, Federal Reserve Bank of Chicago President Charles Evans said Wednesday.

“If the downside risks dissipate and the fundamentals continue to be strong, I expect that eventually the fed funds rate will rise a touch above its neutral level — say, up to a range between 3 and 3-1/4%,” Evans said in a speech in Illinois, according to prepared text released by the Fed. That would put rates in a range above the 2-3/4% long-run neutral level suggested by the latest median forecast of the Federal Open Market Committee.

While Evans said rates could become restrictive “eventually,” for now, with inflation tame, “I feel we have good capacity to wait and carefully take stock of the incoming data and other developments. If they warrant meaningful adjustments to my modal outlook or the balance of risks to the economy, then I would change my views of the appropriate path of policy accordingly.”

Last year was “very strong,” with about 3% growth in gross domestic product, above the long-run norm, and “solid fundamentals” suggest 2019 will be “another good year,” with above-potential, but decelerating, growth near 2%.

“I think developments in the first half of 2019 will be very important for making this assessment of our future monetary policy actions,” he said, noting a “need to be mindful of carefully weighing the various crosscurrents and discerning the more fundamental changes in the economic and financial environment — in either direction.”

As for uncertainties in the forecast, Evans mentioned slowing foreign economic growth, Brexit, and trade talks with China. Also, “the U.S. fiscal policy picture is unclear,” he said. “In addition to the near-term risk of a prolonged government shutdown, there are questions about the feasibility of shaping an appropriate fiscal policy response to any future downside shocks.”

Financial markets have also been a concern. “Since the beginning of October, stock prices have declined noticeably, equity market volatility has increased, corporate bond spreads — particularly for riskier firms — have widened, and the exchange value of the dollar has risen,” he said. “Taken together, these amount to a tightening in financial conditions.”

With this uncertainty, Evans said, the Fed will be data-dependent, “which means we will continually monitor global and financial developments to assess their implications for the economic outlook and the stance for policy.”

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Monetary policy Charles Evans Federal Reserve Federal Reserve Bank of Chicago FOMC