Strong economy may mean more interest rate hikes are coming
San Francisco Federal Reserve President John Williams says significant risks to the economy have faded for the first time since the recession and stronger growth could force the Fed to raise interest rates more rapidly than anticipated.
In a recent interview, Williams, who Trump is considering as vice chairman of the Fed’s board, said he’s comfortable with Fed policymakers’ median forecast of three quarter-point rate hikes in 2018. But he believes there’s a greater chance of faster growth and inflation prompting four rate increases than of slower gains forcing a pullback to two bumps.
“There is some potential the economy is going to outperform my forecast,” he said. “I’m not really worried about the economy stalling, which was a concern a few years ago.”
Barring a downturn in the economy’s performance over the next two months, he said it appears likely the Fed will raise its benchmark shortterm rate in March, as markets anticipate, to a range of 1.5% to 1.75%. But he stressed that economic data in coming weeks will guide the Fed’s decision.
Williams also said he believes the tax cuts signed into law by President Trump last month will boost the economy modestly and won’t crimp growth in a couple of years by swelling the deficit and pushing up borrowing costs. That sanguine view contrasts with many economists’ forecasts that the tax overhaul will serve as a drag on growth as soon as 2020.
Williams’ outlook is noteworthy not only because he may take the Fed’s No 2. role. He’s also considered a cen-
“I think the economy has very solid momentum. I think we’re in a good place.” John Williams San Francisco Federal Reserve president
trist who has voted in lockstep with both outgoing Fed Chair Janet Yellen, a Democrat, and Republican Fed Governor Jerome Powell. Powell is scheduled to take the Fed’s reins from Yellen next month after his expected Senate confirmation. Williams, who was Yellen’s research director when she headed the San Francisco Fed, will be a voting member of the Fed’s interest-rate setting committee this year.
Not long ago, Fed officials worried that hiking rates at even a moderate pace could derail a recovery from the Great Recession of 2007-09. But Williams cited the current confluence of positive economic forces, including a resurgent global economy and record stock prices. “I think the economy has very solid momentum,” he said.
Speed bumps ahead?
Not that the economy doesn’t face speed bumps that continue to restrain growth. Those include vestiges of the recession, such as cautious lenders and fewer business start-ups. Those scars are “probably going to be with us for the foreseeable future,” Williams said. He also highlights long-term challenges such as an aging population and sluggish gains in productivity, or worker output.
The tax cuts, he projects, will result in “a little bit faster” growth, adding about a quarter percentage point a year for the next three years, largely by spurring businesses to increase investment and become more productive. By lowering individual tax rates, he said the plan also could draw some Americans back into the workforce, adding as much as another percentage point to economic output over a decade. Still, Williams said, “We don’t need a stimulus right now in terms of short-run growth.”
At the same time, he disagrees with economists who believe the benefits of the tax overhaul will be offset by a
$1 trillion to $1.5 trillion rise in the federal deficit that will drive up long-term interest rates and discourage borrowing and economic activity.
“Because of the size of the tax cuts, there’s not going to be dramatically higher interest rates,” he says. He expects the added debt will increase long-term rates by about a quarter percentage point over the next few years. Williams forecasts economic growth of about 2.5% both in 2017 and this year, 2% in 2019 and a slowdown to
13⁄ 4% over five years. The economy has expanded at a tepid 2.1% average pace during the recovery. Trump has vowed his agenda of lower taxes and fewer regulations will deliver 3% growth.
Williams also downplays fears that the economic stimulus from the tax overhaul will lead to an excessive runup in wage growth and inflation, especially with the 4.1% unemployment rate already sparking worker shortages. He points to long-term factors that have suppressed consumer price increases, such as slower-growing health care costs due to reduced government spending on Medicare.
“I’m not really worried about inflation taking off,” he says.
Slow wage growth, inflation
In fact, many economists have been puzzled that average annual wage growth has been stuck at about 2.5% the past couple of years despite the low jobless rate.
But Williams said it wasn’t until last year that the economy strengthened and unemployment fell below a normal 4.7%, increasing the competition for workers.
“I expect upward pressure on wages to really show up in 2018 and 2019,” he said. He foresees pay increases approaching 3% by the end of the year.
That, he says, should help nudge the Fed’s preferred measure of annual inflation from 1.5% toward its 2% target over the next two years.