Powell’s Fed gamble
Officials confident they can run economy hot without inflation
Federal Reserve officials are sounding increasingly confident they can run the U.S. economy hot without a harmful rise of inflation, a risky gamble for Chairman Jerome Powell with unemployment low, price pressures edging higher and fiscal stimulus about to goose growth.
An improving inflation outlook has helped advance 10-year U.S. Treasury yields to a fouryear high above 3 percent, pushing the dollar to its strongest levels in three months. Yet policymakers are expected to leave interest rates on hold at their meeting next week and signal no change to the gradual tightening path they’ve penciled in for two or three more 2018 hikes.
Their caution, shaped by the post-crisis years in which they struggled to lift inflation, is a departure from the preemptive strategies of U.S. central bankers in past business cycles to stay abreast of the economy’s turns.
It’s not just the doves who sound relaxed. Loretta Mester, the more hawkish head of the Fed Cleveland, said last week that she doesn’t expect inflation to pick up sharply and “this argues against a steep path” of rate hikes. John Williams, the San Francisco Fed president who shifts in June to run the New York Fed, said he doesn’t “see signs of anything I look at, or others do, of inflationary pressures really building.”
The Fed’s laissez-faire response is an experiment that carries big risks and rewards. The central bank forecasts keeping rates at a stimulative setting — below the so-called neutral level that neither supports nor hinders growth — until the end of next year. Only in 2020 do they project a policy stance that would be tight, with rates seen at 3.4 percent by yearend compared with a neutral estimate of 2.9 percent.
Adding momentum this year are $1.5 trillion in tax cuts and $300 billion in new federal spending. President Donald Trump argues that the tax overhaul combined with deregulation will help the economy accelerate at a time when the labor market is already stretched.
Fed officials are “taking a risk, or rather it has been taken for them because of badly timed fiscal stimulus,” said former Fed Governor Laurence Meyer, who runs a policy research firm in Washington. “They can’t prevent an overshoot, so the question is can they contain it without causing a recession?”
Such an outcome would be “an immaculate soft landing,” he says, where they tighten just enough to curb inflation but without causing severe damage to growth and employment.
U.S. central bankers are aware of the gamble, and say they have good reasons for making it. Minutes of their policy meeting in March show them discussing how a strong economy could help them achieve their 2 percent inflation target — a goal they’ve missed for most of the past six years.
“The history of the Fed isn’t’ very successful at this,” said Ethan Harris, head of global economics research at Bank of America in New York. “Is it worth trying? Yes.”