WASHINGTON (AP) – With ultra-low interest rates even as the US economy improves rapidly, Federal Reserve officials are divided over how quickly they should adjust their policies.
Should they start withdrawing their extraordinary support for the economy soon enough? Or should they wait until the labor market approaches full health?
Many Fed policymakers agree on one thing: The economy is strengthening faster than they expected.
In an interview this week with the Associated Press, Mary Daly, president of the Federal Reserve Bank of San Francisco, offered her own perspective.
“It is appropriate to consider reducing asset purchases later this year or early next year,” she said. “I really see the economy as being able to start to function more and more on its own, which means we can take some out of our housing.”
Still, she remains cautious about withdrawing central bank support, noting that “we are far from full employment”, one of the Fed’s central goals.
On Friday, the government announced that employers created 850,000 jobs in June, the largest gain since August and a sign that the economic recovery remains strong. Still, the unemployment rate fell from 5.8% to 5.9%, still well above the pre-COVID level of 3.5%.
Some other regional bank presidents have indicated they want to start cutting back on Fed support in the coming months. The Fed has set its benchmark interest rate – which influences the cost of borrowing for consumers and businesses – at zero since March 2020, when the viral pandemic erupted.
The central bank is also buying $ 80 billion per month in treasury bills and $ 40 billion per month in mortgage-backed securities in an attempt to keep long-term rates low and encourage more borrowing and expenses.
On Wednesday, Robert Kaplan, director of the Dallas Federal Reserve, told Bloomberg News that he’d rather start cutting back on those purchases “as soon as possible.”
“If we take our foot off the accelerator slowly now,” Kaplan said, “we will have more flexibility on the road to avoid more abrupt actions or serious actions in the future.”
James Bullard, chairman of the St. Louis Fed, and Raphael Bostic, head of the Atlanta Fed, have expressed support for the Fed’s short-term rate hike next year – long before policymakers of the Fed as a whole expected that they will.
Since December, the Fed’s official position has been that it must see “further substantial progress” towards its dual target of full employment and annual inflation of just over 2% before it begins to reduce its bond purchases.
“There is a strong and visible disagreement about (…) the gradual reduction and take-off of Fed rates among (Fed) members,” wrote Kathy Bostjancic, chief financial economist in the United States at Oxford Economics, in a note to clients. “It creates confusion as to the political direction. “
Daly, one of this year’s voting members of the Fed’s rate-setting committee – a role that rotates between regional bank chairmen – discussed these issues and his view on climate change in the interview. The interview has been edited for length and clarity.
Q. In June, Fed policymakers signaled that a first rate hike could take place in 2023, after previously predicting that a hike would only occur later. Did you change your projection for a hike?
A. Let me start by saying that I am increasingly optimistic about the recovery of the economy. The pace of vaccination has been faster than I expected, and the response from consumers and businesses to the regained freedom has been truly remarkable. This tells me that people are ready to re-engage, so all of this bodes well for the economy, and I remain very optimistic about the outlook. The projections are now three weeks old, and I wouldn’t want to go back and think about it. I look to the future: how long will the momentum persist? Will there be additional risks that will come to our shores as a result of the global economy still grappling with the pandemic?
Q. If the economy is improving faster than expected, how does that affect your view of Fed policy?
A. Right now it affects when I think we should start talking about our asset purchase plans, and we’re ready to start discussing when to cut bond purchases, the pace of the reduction, of the composition of the reduction, all of those things are on the plate now. And I think it’s appropriate.
Consideration should be given to gradually reducing asset purchases later this year or early next year. I really see the economy as being able to start operating more and more on its own, which means that we can take a little out of our housing. Of course, not the majority. Because we are still not close to our full employment targets.
Q. Do you think the inflation numbers, now above the Fed’s 2% target, essentially hit the target of price increases moderately above 2% for a while?
A. Let me talk about what I mean by average inflation of 2%. It is an average inflation which is sustainable at 2%. So temporary moves, either very high or very low, is not something I can count on to ensure price stability for the US economy. I wouldn’t put a lot of weight on it. What I’m looking for is sustainable core inflation of 2% on average, and that’s price stability.
Q. Some of your colleagues talk about cutting mortgage purchases faster than Treasuries because housing is hot and doesn’t need Fed support. What do you think?
A. Should we think of mortgage purchases any differently than we think of more Treasuries? It is possible, but I think these are open questions, as mortgage backed securities also keep long-term rates low. You can see that the strength of the housing market has really helped people, not just home buying. But what people often forget is that it helps people get refinancing. When people refinance, they get a lower interest rate. They have more money in their pockets, it supports consumer spending, it can support the economy as a whole.
Purchases of Treasury bonds and mortgages both contribute to overall financial accommodation, as financial markets are favorable to economic recovery, and that’s why you can’t just say, “Well, the market housing is strong, let’s pull it away ”. It’s a little more complicated than that. How well does that support lower rates overall, not just this housing market?
Q. What is your outlook for inflation?
A. I think the most likely scenario is where we tend to revert to what I see as the underlying rate of inflation, and that’s the rate of 1.8% to 1.9%. And so I would expect that with the improvements in the labor market, resolving these supply bottlenecks and temporary factors, we would look at an inflation rate of 1.9%, maybe. be 2%, in 2022 and 2023.
Q. How do you see the role of the Fed on climate change?
A. When people say the role of the Fed, they often think that we are going to be doing climate policy or we are going to be active in this space of change of how the climate is changing. And I would say that is not true. We don’t have these levers to pull. These are for our elected officials. But the evolution of the economy depends a lot on the evolution of climate. You have seen record high temperatures in the Pacific Northwest. A friend of mine actually overheated his transmission, he was just driving his regular car. So imagine you use trucking, you depend on transportation services. These are real challenges.
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