Suggesting that the Federal Open Market Committee need not raise interest rates any time soon, Federal Reserve Bank of St. Louis President James Bullard said Friday monetary policy “is likely neutral.”
If rates are neutral — at a level that neither fuels nor restricts the economy “This suggests that it is not necessary to change the policy rate to keep inflation at target,” Bullard said at the Springfield, Mo., Area Chamber of Commerce, according to prepared text released by the Fed.
Offering five rationales for his belief the Fed should be cautious about raising rates, Bullard said the first was that market-based inflation expectations remain below the Fed’s 2% inflation target, which hurts the credibility of the target, he noted.
“By keeping the policy rate steady, the FOMC may be able to appropriately re-center inflation expectations at the target outcome for the next several years,” Bullard said.
Secondly, policy at a neutral level “suggests that it is not necessary to change the policy rate to keep inflation at target.” Bullard said the trend short-term safe real interest rate, or “r-star,” is currently negative. If so, “That analysis also suggests that the nominal policy rate set by the FOMC is already pressing against the upper bound of a neutral setting.”
The third reason Bullard suggested is that the yield curve has flattened, as the spread between the 10-year and one-year Treasury note yields dropping from about 300 basis points in early 2014 to only 72 basis points in the week of May 2.
“The yield curve could invert later this year or early next year if the Committee continues increasing the policy rate and longer-term yields do not move higher,” Bullard warned. And that could signal a coming recession. “It is unnecessary to press policy rate normalization to the point of inverting the yield curve since inflation and inflation expectations are either at or below target.”
Next, he noted, business investment, as a percentage of GDP, has room to grow, with recent tax cuts attempting to spur that growth. “To the extent the corporate tax reform is successful today and over the next few years, the economy could grow more rapidly without inflationary side effects,” he added. “For this reason, I would caution against translating faster real GDP growth into increased inflationary pressures.”
Finally, U.S. labor markets have returned to an equilibrium state. Bullard said, “It is not necessary to disrupt this equilibrium to keep inflation under control given the current macroeconomic circumstances.”