The U.S. economy may only need one rate hike for as long as 2-1/2 years and the Federal Reserve is eroding its credibility by indicating otherwise, St. Louis Fed President James Bullard said on Friday in arguing for an overhaul of how the central bank views and discusses policy.
Bullard called for the Fed to discard its practice of projecting long-run values for things like economic growth and the target policy rate, acknowledge it has little certainty about the future, and state that the economy is not likely to get much worse or much better than it is now, absent some outside shock.
Bullard said he felt the appropriate federal funds rate is around 0.63 percent, roughly a quarter point above where it stands, and will likely stay there "for the foreseeable future."
For the Fed to publish projections that it will rise steadily to historic norms of three or four percent has been misleading.
The Fed's "dot plot" of projected interest rate policy "appears to be too steep. Fed funds futures markets do not seem to believe it. They are priced for a much shallower pace of increases," Bullard said.
"The Fed's actual pace of rate increases has been much slower than what was mapped out by the committee in the past. This mismatch between what we are saying and what we are doing is arguably causing distortions in global financial markets, causing unnecessary confusion over future Fed policy, and eroding credibility of the (Federal Open Market Committee)," he said.
The alternative, Bullard said, is to view the United States as in a sort of equilibrium where growth, unemployment and inflation are unlikely to fluctuate, leaving little reason to change the federal funds policy rate, currently in a range of 0.25 percent to 0.50 percent.
Bullard put that theory into practice at the Fed's meeting this week, leaving his "dot" off the long-range rate projections. In doing so, he signaled he was the lone "dot" that saw only one rate increase between now and the end of 2018.
While that would seem to make the former inflation hawk now the Fed's most dovish member, those labels would not apply as easily under Bullard's way of thinking. Rather than see the economy on a continuum, with the interest rate used to moderate a tradeoff between unemployment and inflation, he said the Fed should instead view the economy as in a "regime."
The appropriate policy rate for that state would remain in place until a recession, productivity surge or other shock causes it to change.
The rate path "is essentially flat over the forecast horizon," Bullard wrote, with key economic variables likely stuck near current values, with growth at around 2 percent, unemployment around 4.7 percent and inflation heading towards and likely anchored at the Fed's 2 percent goal.
Though not cast in those terms, the Fed's latest economic projections, released on Wednesday, show it expects little or no change in growth, unemployment or inflation through 2018.
While Bullard previously advocated for earlier rate hikes, he has been rethinking much about his view of the economy, including that the U.S. and other developed countries might be mired in a world of permanently low interest rates.
Monetary policy usually encompasses estimates of long-run equilibrium growth, unemployment and interest rates that the economy is expected to hover around, as a guide to how the economy might change over time.
Bullard says the current situation may be much more static, an equilibrium that monetary policy has no reason to try to shift.
"On balance, real output growth, the unemployment rate, and inflation may be at or near mean values that could be sustained over the forecast horizon provided there are no major shocks to the economy," Bullard wrote.
"Key macroeconomic variables including real output growth, the unemployment rate, and inflation appear to be at or near values that are likely to persist over the forecast horizon. Any further cyclical adjustment going forward is likely to be relatively minor."
© 2023 Thomson/Reuters. All rights reserved.