U.S. Federal Reserve bigwigs are short of signposts on the path to higher interest rates. New York Fed president William Dudley thinks rates should rise slowly, Philadelphia’s Charles Plosser reckons they should go up faster, and James Bullard of St. Louis has crunched numbers implying rates should already be at “normal” levels.
Mr. Dudley said on Tuesday that there should be considerable delay before the “liftoff” of the fed funds rate from its current near-zero level and that the overnight benchmark should then rise only slowly. He also floated the idea that the Fed’s $4.3-trillion (U.S.) portfolio should not run off immediately after its bond purchase program ends, but should be reinvested until after rates have begun to go up.
On the same day, though, Mr. Plosser said that stocks and housing were on a firm footing and rates should rise relatively quickly after bond purchases end, which will happen in the fall if the current pace of reductions in the program continues. One of his worries is the potential for inflation to build.
Both Mr. Dudley and Mr. Plosser leave room for the guessing game about when the Fed will start hiking rates – some time in 2015 is the consensus – and how fast. Mr. Bullard, though, implied something different in a presentation last week. He quantified the Fed’s distance from its twin policy goals. He showed that at present the U.S. central bank is closer to objectives of 5.4-per-cent unemployment and 2-per-cent inflation than in 60 per cent of the period since 1960.
One conclusion is that interest rates should already be close to normal levels rather than near zero, although Mr. Bullard suggests still-recovering labour markets and low inflation justify the discrepancy. But what’s normal? Traditionally a fed funds rate of about 2 per cent above inflation is thought of as some kind of equilibrium, or a nominal rate of around 4 per cent.
Mr. Dudley and others, however, argue that the U.S. economy may require a kind of “new normal” monetary policy with a lower real fed funds rate. That, however, is the next guessing game. For now it’s about starting the liftoff. The divergence among the views of three experienced Fed presidents suggests that six years of unprecedented policies have taken them so far off the beaten track that they are uncertain how to return.
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