Fed Officials Grapple With a Welcome New Problem: Faster Growthby and
Implications of Trump fiscal plans pervade December meeting
Committee focusing on how hot labor market moves prices
It’s a challenge Federal Reserve officials haven’t talked about in years: The economy could start to run faster than they anticipate, forcing them to raise rates at a quicker pace.
Minutes from their Dec. 13-14 policy meeting released Wednesday in Washington showed U.S. central bankers preparing for a labor market that could stage a “sizable undershooting” of the jobless level that keeps prices stable in the longer run. That may push them to “raise the federal funds rate more quickly than currently anticipated” to keep inflation in check.
The long shadow stalking the committee’s faster growth scenario is that of President-elect Donald Trump and his tax reform and fiscal stimulus proposals, although he was never mentioned in the minutes by name. Almost all the participants “indicated that the upside risks to their forecasts for economic growth had increased as a result of prospects for more expansionary fiscal policies in coming years,” according to the minutes.
That said, the record of the meeting gave little direct hint of when U.S. central bankers would raise rates next. In December they increased rates for only the second time in a year and signaled they could shift to a faster pace of increases to keep inflation in check, raising the number of quarter-point rate hikes they foresee in 2017 to three from two.
“There is a little more conviction that the fiscal stimulus we will see out of the Trump administration will be positive for growth and inflation sooner rather than later,” said Erik Weisman, chief economist at MFS Investment Management in Boston, a global asset management firm. “That’s surprising because we don’t know any of the particulars at this point.”
Policy makers must assess how inflation will respond as the labor market starts to use any remaining slack. Officials estimate the level of full employment -- or the unemployment rate consistent with labor supply and demand being in balance in the longer run -- at 4.8 percent. Even so, they estimated that growth of 2.1 percent in 2017 would be sufficient to push the jobless rate to 4.5 percent in the final quarter of the year. The U.S. jobless rate was 4.6 percent in November.
“If the tightening of the labor market is leading to higher average hourly earnings, that is going to have a bigger effect on how the Fed views the rate path,” said Omair Sharif, senior U.S. economist at Societe Generale in New York. “That’s more at the forefront of their thinking in 2017 than whatever the fiscal package will look like and its eventual impact on growth and inflation.”
Some overshoot on inflation would be welcome. Prices, measured by the Fed’s preferred personal consumption expenditures index, rose only 1.4 percent in November, the 55th month in a row that the committee has missed its 2 percent inflation target.
Fed Chair Janet Yellen has reminded her committee that the Fed has a dual mandate -- stable prices as well as full employment, and that a tight labor market could help firm prices toward the target.
The minutes stressed this point: “With inflation still below the committee’s 2 percent objective, it was noted that downside risks to inflation remained and that a moderate undershooting of the longer-run normal unemployment rate could help return inflation to 2 percent.”
Wages and Inflation
“They are going to be looking at how wages and inflation evolve,” said Laura Rosner, senior U.S. economist at BNP Paribas in New York.
Another big message from the minutes was that policy makers are facing a world of high uncertainty. They don’t know when Trump’s new fiscal policies will be signed into law, how the economy will respond, or how big the stimulus will be. A stronger dollar, in the meantime, could hold down inflation and exert a drag on U.S. growth through slower exports.
The Bloomberg Dollar Spot Index, which measures the greenback against 10 global currencies, had appreciated 5.2 percent between Nov. 8 and the end of FOMC’s meeting on Dec. 14. Since then it has strengthened an additional 1.1 percent.
“Many participants emphasized that the greater uncertainty about these policies made it more challenging to communicate to the public about the likely path of the federal funds rate,” the minutes said.
Rosner said a rate hike in March is unlikely because there will still have been little clarity on which policies Trump will pursue and what Congress will support, and hence no reason for the Fed to abandon its gradual policy approach.
“There is no rush here,” she said. “They are going to need to wait for some of this uncertainty to resolve.”