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Friday, June 17, 2005

Kansas City Fed’s Hoenig Defines Neutral Fed Funds Rate, Says Ignore Yield Curve

Kansas City Federal Reserve Band President Thomas Hoenig said that his preference is for the Fed to move the federal funds rate to a neutral range, 3.5% - 4.5%, sooner rather than later given the strength in output growth. However, he notes this prescription is data dependent and if future data indicate slower growth, then the pace of rate increases should slow as well. He also says he doesn’t have an explanation for a flattening yield curve, but implies that isn't a problem because the yield curve is not a focus of policy:

Hoenig Sees Neutral Rate ‘Sooner Rather Than Later’, Bloomberg: Federal Reserve Bank of Kansas City President Thomas Hoenig said the benchmark U.S. interest rate may need to rise to a neutral level "sooner rather than later," depending on the pace of U.S. economic growth. Economists estimate the neutral interest rate, which neither spurs nor restrains the economy, is 3.5 percent to 4.5 percent, Hoenig said in a speech to bankers today in Wichita, Kansas. "That's the range that we have to shoot for," said Hoenig, adding that his remarks aren't intended to forecast where rates actually will end up. "… we would want to be in that range sooner rather than later." … How quickly the Fed's benchmark rate reaches neutral, and whether it does so at all, are "unpredictable because we are, in fact, data dependent," Hoenig said. … "If there was, in fact, a slower growth rate by whatever amount, then you might judge it necessary to go more slowly." The U.S. economy is operating at a "strong, healthy pace," Hoenig said. "There has been an increase in the levels of inflation and if we continue to grow at a strong pace, that may become more of a data series we want to watch carefully." Hoenig said he does not know why the yield curve, a pictorial representation of yields on Treasury securities across the maturity spectrum, is flattening. "I wouldn't want to manage that yield curve as a policy maker. That would be foolhardy," he said.

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