Fed's Williams Sees Gradual Policy Tightening of Three Hikes

  • Economy as close to Fed’s twin goals ‘as we’ve ever been’
  • Undershooting full employment risks overheating: Williams

Fed's Williams on U.S. Economy, Inflation, China

Federal Reserve Bank of San Francisco President John Williams said three interest-rate increases this year makes sense as the central bank takes gradual steps to tighten monetary policy and shrink its balance sheet to prevent the economy from overheating.

“The U.S. economy is about as close to the Fed’s dual mandate goals as we’ve ever been,” Williams said in Singapore on Monday. “It’s more important than ever for monetary policy to work toward what I like to call a ‘Goldilocks economy’ -– an economy that doesn’t run too hot or too cold.”

Williams doesn’t vote on monetary policy this year, but he worked closely with Fed Chair Janet Yellen when she led the San Francisco Fed and he was its director of research, and is seen as an influential voice at the central bank.

Williams said a total of three rate increases in 2017, including the one in March, was sensible, with inflation set to approach the 2 percent target within a year. Investors see a roughly 80 percent chance of an increase at the Fed’s next meeting, scheduled for June 13-14.

Three Hikes

"My view still is that three rate hikes this year makes sense,” he told reporters before the speech. “Nothing has pushed me away from that. We should continue this gradual process of policy normalization in interest rates.”

The Fed is confronted with conflicting economic signals. On one hand, unemployment has dipped well below the level most officials think is sustainable in the longer run, dropping to 4.4 percent in April -- which Williams acknowledged in his speech at the Symposium on Asian Banking and Finance. Growth in the U.S. economy will probably be slightly less than 2 percent this year, he said.

Meanwhile, inflation is easing. Fed policy makers prefer the Commerce Department’s inflation index, and by that gauge both headline and core price gains have slipped from earlier this year.

“With the economy doing well and some of the factors that have held inflation down waning, I expect we’ll reach that goal by next year,” he said.

Gradual Exit

Fed officials are discussing how to begin unwinding their $4.5 trillion balance sheet, swollen from asset purchases in the years following the global financial crisis. They expect to release a plan detailing a gradual exit before starting the actual run-off later this year, based on policy maker comments and minutes from the Fed’s May meeting.

Officials want to make balance sheet draw-down as low-key as possible to avoid disrupting markets: the goal is to chart out a preset course and then leave it on autopilot. The minutes suggested that the Fed might set caps limiting how much rolls off each month, then gradually increase those caps every quarter until they reach a terminal level.

“I’m not as worried about a severe reaction globally like the taper tantrum to this normalization of our balance sheet,” Williams said. “We’re already raising interest rates. So pulling back on the balance sheet gradually, slowly over years, that’s just moving consistent with what we’re doing with our other tools.”

“If there were to be some sort of deteriorating of the economic outlook, or another unforeseen circumstance, this timetable would, of course, have to be altered,” he said.

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