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 The paper by four top U.S. economists, presented on Friday to a
roomful of powerful central bankers in New York, argues the Fed
would be wise to keep rates at rock bottom for longer than planned
and then tighten monetary policy more aggressively.
New York Fed President William Dudley, who offered a critique of the
paper, cited currently low inflation and warned against being too
anxious to tighten monetary policy.
The risks of hiking rates "a bit early are higher than the risks of
lifting off a bit late," he told a forum hosted by the University of
Chicago's Booth School of Business. "This argues for a more inertial
approach to policy."
The U.S. central bank is in the global spotlight as it weighs when
to lift rates after more than six years near zero, and how quickly
to tighten policy thereafter.
Some policymakers, like Cleveland Fed President Loretta Mester,
caution against waiting too long, given concerns about potential
financial stability and an erosion of public confidence in the
economy.
Fed Vice Chair Stanley Fischer, answering a question at the forum,
said without hesitation that the central bank will hike rates this
year despite some second-guessing among investors. The first rate
hike is "getting closer," he said, adding that the central bank will
not follow a pre-determined path of tightening thereafter.
The paper's authors, like Dudley, offer a somewhat dovish solution
to the dilemma of when to begin.
They conclude that the Fed cannot be certain to what level it should
aim to ultimately raise its key rate. But this equilibrium level,
they say, has not fallen as low as claimed by those who warn of a
"secular stagnation" in the United States.
Given the uncertainty, "there may be benefits to waiting to raise
the nominal rate until we actually see some evidence of labor market
pressure and increases in inflation," wrote the economists,
including Jan Hatzius of Goldman Sachs and Ethan Harris of Bank of
America Merrill Lynch.
They suggest a "later but steeper normalization path" for rate rises
than the Fed's own predictions, which imply the first hike around
mid-2015 followed by more. Under median forecasts for Fed
policymakers, the fed funds rate would hit about 1 percent by year
end and 2.5 percent a year later.
U.S. SECULAR STAGNATION 'UNCONVINCING'
Fed Chair Janet Yellen said on Wednesday "we don't yet know what the
new normal is" in terms of growth.
But the paper offered an optimistic defense of U.S. resilience in
the face of a growing chorus of pessimists, including former
Treasury Secretary Lawrence Summers, who have argued that
persistently weak demand for capital means Americans need to get
used to a less muscular economy.
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Mester also critiqued the paper at the forum attended among others
by former Fed Chair Ben Bernanke and the second-in-commands at the
European Central Bank and the Bank of Japan.
Mester said economists were more apt to estimate how raising rates
too soon would have on employment and lost output, "but they are
less likely to quantify the costs of waiting too long."
The paper cited decades worth of data from many countries to
conclude that, contrary to much economic theory, trend economic
growth is not a clear determinant of where a central bank should aim
to settle its policy rate over the long run.
In an acknowledgement that the U.S. economy may not be able to grow
at its pre-recession rate, in recent years Fed officials have
slightly lowered their forecasts of this equilibrium rate from a
longstanding assumption of 4 percent.
The co-authors, including professors James Hamilton and Kenneth West
of the National Bureau of Economic Research, suggest it has fallen
only slightly to perhaps 3-4 percent.
Dudley, a permanent voter on monetary policy and a close ally of
Yellen, said the fed funds rate will likely settle around 3.5
percent.
Using Fed computer models, the paper suggested that rates should
rise about six months later than otherwise planned, and that the
pace of hikes should be one-third faster, leading to a modest
overshooting of the equilibrium level.
The Fed, the ECB and others have slashed borrowing costs to record
levels and purchased trillions of dollars in bonds to boost
inflation and kick-start recovery from the 2007-2009 recession.
Investors expect the Fed to be first among major central banks to
tighten, later this year.
(Additional reporting by Howard Schneider and Michael Flaherty;
Editing by Chizu Nomiyama)
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