Fed’s Brainard Says Fiscal Policy Could Speed Rate Increasesby and
Expansionary budget could trigger inflation, higher debt
Economic risks ‘closer to being balanced’ than for some time
Federal Reserve Governor Lael Brainard said the U.S. central bank may accelerate interest-rate increases and measures to shrink its balance sheet if Congress approves a sustained, material increase in fiscal stimulus that pressures inflation without lifting productivity.
“Based on recent spending indicators, we might expect progress to continue to be gradual and steady,” Brainard said Tuesday in Washington. “However, if fiscal policy changes lead to a more rapid elimination of slack, policy adjustment would, all else being equal, likely be more rapid than otherwise.”
Brainard’s remarks come as the U.S. central bank wrestles with uncertainty surrounding the shape of fiscal policies of the incoming administration and how they’ll affect the economic outlook. President-elect Donald Trump has promised tax cuts and increased spending on infrastructure and defense -- actions that could boost growth and inflation.
Brainard, a policy dove who has previously argued for patience in raising rates, also said such a fiscal boost may mean that the conditions set by the Fed for halting balance-sheet reinvestment may be “met sooner than they otherwise would have been.”
Her comment refers to a Fed commitment to not shrink its $4.5 trillion portfolio of Treasuries and mortgage backed securities until rate hikes are well under way. Several regional Fed bank presidents said last week they favor debating the balance sheet this year.
With around $600 billion worth of Treasuries held by the Fed maturing in 2017 and 2018, a decision to halt reinvestment could push up U.S. bond yields because it would reduce an important source of demand -- unless that were offset by demand from elsewhere. Complicating matters, that process could be unfolding as bond investors assess the implications of the new administrations’ policy choices. If those increase the deficit, that could imply more debt supply by the government to fund the budget shortfall.
Brainard did not explore the implications for the bond market in her speech. But she did stress the importance of focusing fiscal policy on raising productivity and pulling more Americans into the workforce, in order to deliver a lasting increase in living standards.
“Fiscal expansions that affect only aggregate demand, and are enacted when the economy is near full employment and 2 percent inflation, are relatively less likely to sustainably boost economic activity and relatively more likely to be accompanied by increases in interest rates,” she said.
The Fed raised its benchmark lending rate Dec. 14 by a quarter percentage point and signaled it favors three hikes in 2017, based on the median estimate of policy makers’ forecasts. In her press conference that day, Chair Janet Yellen referred to future budget policy as a “cloud of uncertainty” hanging over the U.S. economic outlook.
Several Fed officials have said the central bank is close to fulfilling its dual mandate for maximum employment and stable prices. Joblessness, at 4.7 percent in December, has already reached what most officials consider the lowest sustainable level. The Fed’s preferred measure of inflation, excluding food and energy, reached 1.6 percent in the 12 months through November, bringing it “pretty close” to the central bank’s 2 percent target, according to Yellen.
“In sum, the economy continues to make gradual progress toward our goals,” Brainard said, adding that a gradual approach to interest rates would remain appropriate as long as the economy remained short of the Fed’s objectives.
Risks in the domestic economy were “closer to being balanced than they have been for some time,” she said, adding, however, that substantial risks remained in Europe, Japan and emerging markets including China.
Expansionary fiscal policy that mainly increased demand, she said, could create inflationary pressures, increase the size of the federal debt relative to the economy and strengthen the dollar.
“Against the backdrop of deficient demand abroad, if more expansionary fiscal policy here at home raises expectations of a growing divergence between the United States and other economies, upward pressure on the exchange rate will likely result,” she said.
A strengthening dollar can hurt U.S. growth by making exports less competitive.
New York Fed President William Dudley, speaking earlier on Tuesday, separately said the central bank wouldn’t likely be forced into an aggressive rate-hike campaign that would snuff out the economic expansion “because inflation is simply not a problem.”