Fed’s Williams pushes case for rates rise

Posted on September 7, 2016

Federal Reserve President John Williams

John Williams, president of the Federal Reserve Bank of San Francisco

The Federal Reserve should increase short-term interest rates again sooner rather than later, a senior US policymaker said, as he set out a bullish outlook for the jobs market and broader economy.

John Williams, the president of the Federal Reserve Bank of San Francisco, said the US economy was now at full strength following the recovery from the financial crash and that it made sense for monetary policy to respond.

    The jobs market was on course to add twice as many jobs this year as needed to keep pace with the trend growth in the overall labour force, he said, with unemployment set to bottom out at 4.5 per cent over the next year compared with 4.9 per cent currently. While inflation has persistently run below the Fed’s 2 per cent target for a number of years, Mr Williams predicted that price growth would return to that goal over the next year or two.

    “The economy has climbed back to full strength, and it therefore makes sense to move monetary policy gradually back to normal,” Mr Williams said in a speech in Nevada. “In the context of a strong economy with good momentum, it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later.”

    Markets are currently trying to untangle clashing signals from the Fed’s body of policymakers as they gauge the chances of a second increase in rates as soon as this month. In the wake of a mediocre jobs report this month traders have been betting more heavily on rates staying put than moving on September 21, with CME Group’s analysis of futures trading putting the odds of a move at less than one in five.

    But a number of Fed policymakers are signalling that they are in favour of a move, among them Mr Williams, who is currently not a voter on the rate-setting Federal Open Market Committee. He has been ploughing a hawkish furrow recently as he argues that the Fed needs to respond to the return to full employment as well as instability hazards if rates stay too low for too long.

    Mr Williams reiterated the latter risk in his speech, arguing that gradual increases in rates would help to mitigate the danger of economic and financial overheating. “History teaches us that an economy that runs too hot for too long can generate imbalances, potentially leading to excessive inflation, asset market bubbles, and ultimately economic correction and recession,” he said.

    In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher

    – John Williams

    Mr Williams also repeated previous arguments that with a depressed neutral rate of interest — the rate that neither stimulates the economy nor holds it back — it made sense for the Fed to reconsider some basic aspects of its framework.

    The implication of the low neutral rate was that there would be less room for rate cuts to kick-start growth in the next downturn. “In this new normal, recessions will tend to be longer and deeper, recoveries slower, and the risks of unacceptably low inflation and the ultimate loss of the nominal anchor will be higher,” he said.

    Fed policymakers have already been lowering their estimates of where the federal funds rate is likely to level out over the longer term, with the median estimate currently standing at 3 per cent. Some policymakers have suggested it could end up being even lower.

    Mr Williams argued that the most direct attack on that state of affairs would be for the Fed to target a higher rate of inflation. “This would imply a higher average level of interest rates and thereby give monetary policy more room to manoeuvre,” he said.

    He also suggested adopting a price level or nominal gross domestic product target might be an alternative answer. “I firmly believe that now is the time for experts and policymakers around the world to actively study and assess the pros and cons of alternative proposals, so that we are better prepared for the challenges related to persistently low natural real rates of interest,” he said.

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