Richard Clarida was nominated today to be Vice Chairman of the Board. He joins the Chair Jay Powell, and the incoming president of the New York Fed, John Williams, on what we call the Troika, the three-person group that has ongoing interaction about the outlook and monetary policy. (See our January commentary for more detail on his previous experience.) Today, he regards the unemployment rate as being well below the NAIRU and still falling while inflation is expected to head toward 2%. He questions participants’ projections that show an unemployment rate below the NAIRU and still falling. Yet, inflation is not overshooting the 2% objective, and the fund’s rate not moving above its neutral level. This places him on the hawkish side of the FOMC and puts him in line with John Williams. We expect both favor four hikes in 2018.
A View of R-Star: The New Neutral
Clarida was an early proponent of the idea of a new normal for the neutral fund’s rate. Along conventional lines, he attributed the decline in r-star to lower potential growth. Last year, he thought it was 2% to 2½%, but that was before the fiscal stimulus which we expect has raised the neutral rate. If his estimate rose by about 25 basis points, it would still be slightly lower than participants’ current median estimate, now 2.9%. But he will have an opportunity to shape his views and benefit from talking to Laubach, Williams, and others within the Fed who have studied this topic.
Clarinda’s Likely Policy Inclinations: Hawkish Side of Center
1. He has said the Committee may have remained too accommodative for too long so that normalization was overdue. A more hawkish view, if the only relative to the extraordinarily dovish policy the FOMC followed. That suggests he wants to catch up, is concerned about falling below the curve, and worried about the higher probability of a recession.
2. He believes in forward-looking, or forecast-based, monetary policy. A more forecast-based monetary policy, and one based on the Phillips curve, put him with the consensus that policy should be driven by the forecast that inflation is headed to 2%, not the recent data, showing a slowdown. That means proceeding with a steady, gradual pace of rate hikes.
3. He thinks the normalization of the balance sheet is being handled well. We suspect he concurs with Powell in favoring the current operating framework and, as a result, a relatively large balance sheet when normalized.
4. He saw an important inconsistency in participants’ projections for some time; the median projection for the unemployment rate is well below the NAIRU, but inflation nevertheless moves back to and stabilizes at 2%. In the FOMC’s March projections, the median for core inflation did overshoot, but just by a tenth. His dot would have been above the median in 2018, 2019, and 2020.
5. In recent remarks, he said: “We could get four hikes if the growth in the economy is stronger because of the tax cuts…But importantly, also, you’d actually need some indication that inflation is moving up too quickly for the Fed’s taste.”
Clarida has said that Yellen has left Powell with two immediate challenges, what he calls “destination” questions:
1. Where is r-star and have fast should the FOMC get there?
2. What should be the size of the normalized balance sheet, tied up with the decisions about the long-run operating framework?
We think there will be a strong consensus on the long-run operating framework: Continue as it is, but we expect he would focus now on what we see as the biggest challenge: balancing the pace of hikes fast enough to limit the degree of overshoot and leans against an even larger decline in the unemployment rather than now projected, while not so fast a pace of rate hikes so as to endanger the expansion. His colleagues will welcome his thoughts.
Community Bank Fed Governor Bowman
Michelle Bowman, a Kansas bank commissioner, was nominated to be the community bank governor. Normally, the community bank governors have less defined views on monetary policy but could still play an important role in the overall Fed communications strategy.