Federal Reserve Bank of Boston President Eric Rosengren Tuesday said the U.S. economy is not yet on the path towards 2% inflation, the central bank’s price stability target, and that the Fed needed to remain “cautious and patient” as it considers a return to normal monetary policy.
“While the eventual return to 2% inflation is in the forecast, I see little evidence in the current data suggesting that we are yet on this modest path to achieving the targeted 2% inflation rate,” Rosengren said in remarks prepared for delivery at Husson University in Bangor, Maine.
The core inflation rate is currently 1.1%, “well below our 2% target,” Rosengren said pointing to a model of inflation used at the Federal Reserve Bank of Boston which “generates only a very slow return to a 2% inflation rate.”
In fact, a slide prepared for his presentation shows the change in the personal consumption expenditure (PCE) still below the 2% target inflation rate as late as the end of 2018.
Rosengren also said Fed-controlled interest rates should stay at a “very low level” until the economy is within one year of that target. “I believe the FOMC’s forward guidance should be consistent with keeping interest rates at their very low level until we are within one year of reaching full employment and our 2% inflation target – and the guidance could explicitly state that intention,” he said.
Rosengren, who will not hold a voting position on the Federal Open Market Committee until 2016, dissented from the December 2013 decision to begin to scale back the purchases of then $85 billion a month in Treasuries and agency mortgage-backed securities. Now, “this gradual tapering is likely to continue as long as the economy’s gradual improvement proceeds,” he said.
While recent incoming data continues “to be consistent with a slowly improving economy,” Rosengren said he believes “there are several reasons to be cautious and patient before returning monetary policy to a more normal, less accommodative stance.”
One of the reasons to continue the “unusually accommodative stance of monetary policy” was that “significant problems in labor markets persist even at this stage of the recovery,” Rosengren said.
The Fed had previously said rates would remain low until the unemployment rate hit 6.5%, but this “does not provide much by way of forward guidance as we approach it,” he said. Plus, the “unemployment rate understates the severity of the problem,” he said.
So at its last policy meeting, the FOMC switched to a more qualitative statement about interest rate intentions. Rosengren admitted this is “somewhat less specific than the previous forward guidance involving the 6.5% threshold.”
Rosengren added the Fed’s forward guidance should, “for the time being, remain qualitative but increasingly be linked to progress” on the dual mandate of full employment and stable prices based on economic data.
“Such guidance would hinge on how far the economy remains from levels consistent with our dual mandate and on the assumed forecasted speed at which inflation and unemployment are expected to converge to those values,” he said.
Forward guidance “should be increasingly focused on how quickly we expect to make progress on inflation that is well below our target, and on the significant underutilization of labor resources” that continues five years after the official end of the recession, he said.
For his part, Rosengren estimates full employment “is around 5.25%,” but he called for forward guidance which would have “much more focus by market participants on a broader set of measures, such as the U-6 measure of unemployment which captures broader utilization of labor resources.”
By structuring forward guidance so market participants paid “more attentive to the incoming data and how the data fit” with FOMC expectations, they would be less focused “on changes in the setting of monetary policy tools,” he said.
As with any economic forecast, Rosengren said some uncertainty in forecasting full employment and 2% inflation “is a given,” but he added uncertainty is currently “compounded by the unusual behavior of some key economic relationships since the financial crisis.”
This “scarring” refers to the “very real possibility that typical economic patterns have been altered by the financial crisis and Great Recession, their lead-up, and their aftermath,” Rosengren said.
One example he pointed to was the role a strong housing recovery plays in many forecaster’s stronger-than-potential GDP growth estimates.
“While most forecasters expect housing to improve, the path of improvement differs greatly among forecasters,” Rosengren said, in part because of a change in trends in household formations, consumer’s risk-aversion and even labor conditions.
Rosengren also points out overseas risks create uncertainty. “My own assumption is that Europe, and the emerging economies, are likely to continue to gradually improve,” he said, but such a “forecast could change significantly if the baseline assumptions about Europe and emerging economies prove to be wrong.”
His example here is Ukraine. “Were problems in Ukraine, for example, to become much more acute, Europe would potentially be impacted by its energy dependence on Russia and also through European bank exposure to emerging European economies,” Rosengren said. “Given that European banks are still recovering from a severe European recession, such a shock – while unlikely and not my prediction – would be most unwelcome.”