Federal Reserve officials remain confident as markets began 2016 on a tumultuous note. Cleveland Federal Reserve President Loretta Mester told Reuters that although she is "pretty comfortable with the median path" of roughly four rate hikes this year, she would prefers a somewhat more aggressive forecast. That is less hawkish than it might seem given that Mester has a more optimistic economic outlook:
"Mester expects the U.S. economy to grow at a 2.5 percent to 2.75 percent pace this year, slightly stronger than the 2.4-percent rate median forecast of her colleagues. That optimism allows her to view more than four rate hikes as appropriate, she said."
In the old days, that would not be considered a particularly optimistic forecast. A somewhat less optimistic San Fransisco Federal Reserve President John Williams today told Steve Leisman at CNBC that he thought the Fed was on track for 3-5 rate hikes. From CNBC's transcript:
LIESMAN: AND THAT'S THE KIND OF GDP GROWTH THAT LEADS YOU TO A MEDIAN RATE HIKE NUMBER, RIGHT? WHICH IS THAT THE 2% GROWTH WAS WHAT THE OVERALL FED IS LOOKING FOR AND THAT WOULD BE COMMENSURATE WITH THE FOUR RATE HIKES?
WILLIAMS: SO NOW I'M GOING TO GIVE MY NORMAL DISCLAIMER THAT I AM SPEAKING ABOUT MY OWN VIEWS, BUT YES. A GROWTH PATH OF 2, 2.25% GDP GROWTH, UNEMPLOYMENT EDGING DOWN IN MY VIEW BELOW 5% THIS YEAR. AND INFLATION CERTAINLY TO MOVE GRADUALLY BACK TO 2% THIS YEAR – ARE THE KIND OF INGREDIENTS I SEE AS FEEDING INTO, YOU KNOW, 3 TO 5 RATE HIKES THIS YEAR. BUT, AGAIN, YOU KNOW, WE'LL WATCH THE DATA.
As Leisman alluded to just before this exchange:
LIESMAN: EXCUSE ME WHILE I YAWN, RIGHT? I MEAN –
Williams forecast is about as dull as it gets. But dull is not such a bad thing. Williams sees this as the slightly above trend growth number that sets the economy on a glide path to a sustainable pace of activity. 2%. It's the new 4%. The reduced estimates of potential growth have lowered the Fed's expectations for growth such that numbers which in the past might be called "stall speed" are now considered good news.
Separately, over the weekend Federal Reserve Board Vice-Chair Stanley Fischer opined on the persistence of low equilibrium real interest rate:
Whatever the cause, other things being equal, a lower level of the long-run equilibrium real rate suggests that the frequency and duration of future episodes in which monetary policy is constrained by the ZLB will be higher than in the past. Prior to the crisis, some research suggested that such episodes were likely to be relatively infrequent and generally short lived. The past several years certainly require us to reconsider that basic assumption.
Fischer considers four potential actions to respond to there zero lower bound: Raise the inflation target (although he worries you can't have higher inflation without more variable inflation), implement negative interest rates (which I suspect is would be political suicide for the Fed), raise the equilibrium real rate (though the primary tool here is fiscal policy), and eliminate physical currency (he argues not practical in the United States). In other words, the tools exist, but implementation is a challenge.
Fischer adds that a sustained low interest rate environment has the potential risk of creating financial instability. He notes that policymakers generally argue that "macroprudential tools" should be the first line of defense against such instability. Fischer however adds:
Despite the tools that the Fed can use to support financial stability, including the Fed's authority to impose margin requirements on secured financing transactions, the Fed has fewer macroprudential tools at its command than some other central banks, particularly with respect to real estate. Regulators in many countries facing or anticipating problems with rising real estate prices often turn to controls over loan-to-value or debt-to-income ratios. Such measures are potentially important, as the real estate sector is the most common source of the beginnings of financial instability. In the United States, responding to such problems with these tools would require interagency coordination, which could make their use cumbersome at critical moments.
Lack of sufficient macroprudential tools thus may require a monetary response instead:
The effective lack of such tools has two important consequences. First, it requires placing greater weight on the ability of financial institutions and the financial system as a whole to withstand financial shocks without the authorities having to use macroprudential instruments--that is to say, on structural reforms to the financial system. Second, in such instances, one could consider using monetary policy--the short term policy interest rate--to lean against the wind of financial stability risks.
Still, the central bank can't raise interest rates for just every potential bubble that comes along:
I would like to conclude on this issue by saying that the issue is a bit more complicated than suggested so far--for, given that financial variables are a critical part of the transmission mechanism of monetary policy, when policymakers say the economy is overheating, they may well be considering the behavior of asset prices as a critical part of that phenomenon and part of the reason to tighten monetary policy. Thus, I believe that the real issue of whether adjustments in interest rates should be used to deal with problems of potential financial instability is macroeconomic, and that if asset prices across the economy--that is, taking all financial markets into account--are thought to be excessively high, raising the interest rate may be the appropriate step.
This sounds to me like Fischer believes that interest rate hikes to counter asset bubbles are only justified if the excessive pricing is widespread throughout the economy. Nonetheless, Greg Robb at MarketWatch reports on speculation that Fischer fueled the negative mood on Wall Street this morning:
A hawkish tone from a key U.S. central banker could be adding to the market’s poor start to 2016.
On Sunday, Fed Vice Chairman Stanley Fischer said the U.S. central bank should be open, in the future, to raising interest rates to ward off potential asset bubbles.
How much financial stability concerns should play in monetary policy remains an unsettled policy at the U.S. central bank. Prior to the crisis, the Fed’s leadership did not support hiking rates to ward off asset bubbles.
In a note to clients, David Rosenberg, chief economist at Gluskin Sheff, said Fischer’s “hint of more rate adjustments” may be adding to “the market angst.”
