Fed Economists Say Long-Term Rates May Exceed Forecasts

The U.S. economy faces a risk that long-term interest rates may be higher than forecast because policy makers may be mistakenly linking the outlook with a reduction in the long-term trend for growth, according to Federal Reserve Bank of San Francisco economists.

“Both monetary and fiscal policy projections have been based on the view that declines in the long-run potential growth rate of the economy will in turn push down interest rates,” Glenn Rudebusch, director of economic research, and Sylvain Leduc, a vice president, wrote in a paper today.

“In contrast, examination of private-sector professional forecasts and historical data provides little evidence of such a linkage,” they wrote. “This suggests a greater risk that future interest rates may be higher than expected.”

Fed policy makers cut their forecast for the long-term neutral federal funds rate, a level that neither kindles inflation nor curbs job growth, to 3.75 percent in June from 4 percent in March. The Congressional Budget Office this year said lower projections of borrowing costs in part reflected reduced forecasts for potential output, the economists wrote.

A study by Goldman Sachs Group Inc. economists that looked at 20 countries found no statistically significant relationship between economic growth and short-term interest rates, the San Francisco Fed writers said.

The Federal Open Market Committee’s participants and the CBO ’’may have overemphasized the effect that weaker potential growth has on damping future interest rates,’’ the economists wrote. That would “translate into an upside risk” to rate forecasts.

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