Philadelphia Federal Reserve Bank President Charles Plosser warned Tuesday the central bank may have to raise interest rates sooner than some expect to combat inflation if it materializes quickly, even though he views the inflation outlook as benign now.
“My own view is that, as we continue to move closer to our 2% inflation goal and the labor market improves, we must be prepared to adjust policy appropriately,” Plosser said in a speech prepared for delivery to the Women in Finance and Housing group. “That may well require us to begin raising interest rates sooner rather than later.”
Plosser, who votes on the Fed’s policymaking Federal Open Market Committee this year, said if the committee “continues this path of measured reductions, the purchase program will end sometime this fall.”
But even after the end of the large-scale asset purchases – which now stands at $45 billion a month – monetary policy “will still be highly accommodative,” Plosser said.
“Reducing the pace of asset purchases in measured steps is moving in the right direction,” he said, “but the pace may leave us behind the curve if the economy continues to play out according to FOMC forecasts.”
Plosser cautioned that “if the economy continues to improve, we could find ourselves still trying to increase accommodation in an environment in which history suggests that policy should perhaps be moving in the opposite direction.”
As for the recovery, Plosser said he believes “the U.S. economy is on a firmer footing today than it has been in several years.”
Despite the slowdown in growth in the first quarter, which “most of us now view this as a temporary weather-related slowdown and not a risk to the underlying recovery,” he said, there is cause for “some optimism for continued progress in 2014.”
Plosser’s forecast has been for GDP growth of about 3% this year, “and while the weather-related softness in the first quarter may temper this full-year outlook somewhat, it hasn’t led me to downgrade my outlook for the remainder of the year.”
One of the “most encouraging signs for the economy comes from the labor market, believe it or not,” Plosser said, pointing to the April payroll increase of 288,000, “the strongest gain since January 2012.”
The unemployment rate, which fell to 6.3% in April, continues its “downward trend,” but he said he would “not be surprised if the unemployment rate moved up a bit next month.”
He noted “the household survey, which gives us the unemployment rate, is more volatile than the establishment survey, which measures the number of new jobs added.”
As for his own unemployment forecast, Plosser said he was expecting a 6.2% unemployment rate by the end of the year, but “given the recent trends, an unemployment rate below 6% is certainly plausible.”
On price stability, the other part of the Fed’s dual mandate, Plosser said “inflation remains benign,” adding it’s “important to defend our 2% inflation target both from below and above.”
Still, he expects “inflation will move back toward our target over time,” and said he is “encouraged that inflation expectations remain near their longer-term averages and consistent with our 2% target.”
But he said he worries about inflation over the longer term. “Given the large amount of monetary accommodation that we have added and continue to add to the economy, I think there is some upside risk to inflation in the longer term.”
Plosser also said he is optimistic about the housing recovery, noting, “The fundamentals of the housing market remain sound, including stronger household formation, solid job growth, and consumers with stronger balance sheets.”
Fed Chair Janet Yellen in testimony to Congress this month expressed concern with a “flattening” in U.S. housing market activity, which she said posed one of the biggest risks to the economic outlook.
But Plosser seemed to disagree. “Even though sales have leveled off recently, prices have continued to rise even over the past three months,” he said. “That suggests that supply may be restricting sales more than weaker demand.”
Still, “we will have to wait and see how the remainder of the spring and summer plays out.”