Monetary policy is near a neutral level, one that neither stimulates nor restricts economic growth, according to Federal Reserve Bank of Atlanta President Raphael Bostic, who noted that caution should be used going forward.
“I don’t think we are too far from a neutral policy, and neutral is where we want to be,” Bostic said in a speech in Spain, according to prepared text released by the Fed. “We may not be there quite yet, but I am inclined to think that a tentative approach as we proceed would be appropriate.”
Moving “cautiously and keep[ing] a keen eye on the data,” he said, would be the Fed’s best approach to balance the risks of being either too timid or too aggressive.
Should clear signs emerge of an overheating economy, Bostic said, he would be “prepared to support a more aggressive approach than my baseline view.”
While wage growth has been rising — and he calls that “a good thing” — if other signs of inflationary pressures grow, it “would be of concern.”
The Federal Open Market Committee has met its 2% inflation target, and with the unemployment rate at 3.7%, “we are very close to the FOMC’s other key goal — promoting maximum sustainable employment growth,” he said. “Possibly, we have gone some measure beyond.”
Removing monetary accommodation gradually gets part of the credit for the progress, he added. “In my view, conditions warrant the final steps in removing any remaining accommodation and adopting a neutral stance of monetary policy. The question now is as complicated as it is straightforward: What, if any, further adjustments are necessary to get to neutral?”
Since policy is “seemingly within shouting distance of neutral, the FOMC faces both upside and downside risks with its next set of policy adjustments,” Bostic said.” As I see it, the Committee now must balance the risks of stopping short of full normalization and risking an overheated and unstable economic environment, versus going too far and short-circuiting an otherwise sustainable expansion.”
But, he noted, unemployment is below the consensus view of what can be sustained, and since 1960, these conditions ended in recession. “There are many possible interpretations for the leading relationship between high-pressure periods and downturns in the economy. One is that the relationship is entirely spurious. That would be a pretty benign interpretation. I’m not convinced that such a benign interpretation is consistent with good risk management practice,” he said. “I think a risk management approach requires that we at least consider the possibility that unemployment rates that are lower than normal for an extended period are symptoms of an overheated economy.”
While he doesn’t see “evidence of widespread imbalances,” he pointed to the consumer credit market, with “rising delinquencies on consumer credit cards at small banks” as a source of concern. “While they are not currently driving the core of the market, rising delinquencies that manifest in the small bank sector may spill out and become a broader issue.”
An overheating economy also spurs inflationary pressures, “leading the central bank, in turn, to respond aggressively, and economic weakness follows.”
Not responding aggressively to signs of growing inflation seems to be the answer, Bostic noted, “but that would entail risks that few responsible central bankers would accept.”
While inflation expectations are stable, that can change quickly, he added.
“The main uncertainty, as I see it, is that it is very difficult to determine when the economy is actually overheating — especially when inflationary signals across the board remain subdued,” Bostic said.
