Since the December FOMC meeting, comments by policymakers have revealed the beginning of a shift in the focus of monetary policy: Though confirming that the slowdown in core inflation in 2017 was transitory remains a priority, some policymakers seem to be less concerned about that. There was no dramatic shift in sentiment, but we did perceive greater concern about getting behind the curve and a sense of increased upside risks to growth and inflation, especially with the passage of legislation cutting taxes.
The FOMC’s decision to raise the fund’s rate target at its December meeting came as no surprise. Neither did Evans’ and Kashkari’s dissents. The reasoning behind their dovish opposition to the FOMC’s decision remained the same. Evans remained most concerned about the possibility of a decline in longer-term inflation expectations and thought maintaining the fund’s rate target at its previous level would have “better supported a general pickup in inflation expectations” (12/15). Similarly, Kashkari, referring to rate hikes, said, “I think the big cost is potentially anchoring low inflation expectations” (12/18).
Notwithstanding Evans’ and Kashkari’s dissenting views, FOMC policymakers were generally more comfortable with the economic outlook and the path of monetary policy. The consensus seemed now to be somewhat closer to the views of Williams (1/19), who had previously been cleared to the hawkish side of the FOMC. Referring to meeting the Fed’s monetary policy objectives, he said, “We’re very well-situated.” He saw an improving global economy, as well as a fiscal stimulus in the U.S. from tax cuts, “giving you a tailwind,” saying, “All those forces provide me with greater confidence that the US economy is going to continue to grow actually somewhat above trend this year and is on a very good footing in terms of growth.” He saw “greater upside” with respect to both the inflation and growth outlooks.
Pace of Hikes
Dudley continued to point to the FOMC’s median projected pace, but warned that “the risk, not in 2018 but longer-term, is that the economy could actually overheat, that inflation might not stop at 2%, or 2.1% or 2.2%, and then the Federal Reserve would have to step on the brakes a bit harder” (1/18). He also reiterated a point he has emphasized repeatedly, that easing in broader financial conditions suggests that the FOMC will need to “press harder on the brakes at some point over the next few years. If that happens, the risk of a hard landing will increase” (1/11). Kaplan (1/10) also projected three hikes this year and expressed concern about getting behind the curve: “We’re going to have to watch because we want to avoid a situation where we have such an overheating that we’re playing catch-up.” Williams (1/21) continued to have three hikes this year as his base case, but, consistent with his discussion of the balance of risks being to the upside, saw a greater chance of four hikes than of two. He continued to show little concern about low inflation: “Inflationary pressures are clearly starting to build, helping us get back to 2 percent” (1/19). Rosengren stated that he projects more than the median of three funds rate hikes this year (1/12). Mester’s views on the appropriate pace of rate hikes remained somewhat to the hawkish side: She projected “three to four fed funds increases this year, three to four next year” as likely to be appropriate (1/18).
Evans thought the next rate hike wouldn’t be appropriate any earlier than June and saw fewer than the median projection of three rate hikes as likely to be appropriate this year (1/17). Low inflation remained his
primary concern: “we seem to be at a point where we’re not experiencing inflationary pressures” (1/17). Harker’s baseline forecast for inflation had inflation rising above the objective in 2019 (1/5). However, concerns about downside risks to that forecast led him to project only two hikes this year: “I expect inflation will run a bit above target in 2019 and come down to target the following year, but I am more hesitant in this view than I am on economic activity. If soft inflation persists, it may pose a significant problem.” Bostic (1/8) seemed to have a similar baseline inflation outlook and attitude toward rate hikes. He projected two to three hikes this year, wanting to see “the inflation numbers start to move more in line with my expectations” before considering a faster pace.
At the time of the December FOMC meeting, it appeared likely that the Republican tax bill would soon be finalized and passed. As Chair Yellen noted at her postmeeting press conference, FOMC participants did incorporate the effects of the prospective tax cuts in their economic projections, and these contributed to upward revisions to the growth outlook. Comments from FOMC participants suggested that they expected the bill to provide stimulus, but they did not explicitly advocate tighter monetary policy as a direct response. Mester (1/17) saw upside risk to the outlook from tax cuts and cited an estimated effect of between one quarter to one half of a percentage point to growth over the next couple of years. Williams (1/19) mentioned it as one of several factors contributing to a “tailwind” for the economy. Kashkari (12/19) said that “it doesn’t seem like it’s big enough to change my policy forecast.” Dudley (1/18) didn’t advocate tighter monetary policy as a response in the near term but saw fiscal stimulus as contributing to the risk of overheating in the coming years.
There was a noticeable increase in discussion of the implications of the shape of the yield curve, including a potential inversion. It was noted that whereas in the past an inverted yield curve has been a fairly reliable predictor of economic downturns, that relationship has changed for reasons including the decline in term premiums and the longer-run neutral fund’s rate. However, many expressed uneasiness with the prospect of an inversion. For example, Harker (1/5) noted that today’s circumstances are not “analogous to the inversion associated with the stagflation of the ’70s and ’80s.” However, he added, “At this point, I don’t think we should do anything that would precipitate any inversion of the yield curve or other things.” Likewise, Bullard said, “I would not want the Fed to push so hard that we get to an inverted yield curve situation” (1/4).
Kashkari saw the flattening of the yield curve as indicating that the market expects the Fed’s “very hawkish” policy to result in low inflation over a long period (12/18). Kaplan thought the FOMC should avoid a yield curve inversion, saying policymakers should be “very vigilant” (1/17).
Policy Strategy and Frameworks
Policymakers discussed longer-run strategic issues for monetary policy, including changes to the framework. They tended to avoid advocating specific changes and expressed openness to considering a variety of changes. Harker, like others, was motivated by a need “to consider the possibility of a new economic normal that forces us to reevaluate our targets.” However, policymakers indicated that they would follow a cautious approach with respect to considering changes. For example, Mester noted that “None of these alternative frameworks [raising the 2 percent inflation target, permanent and temporary price-level targeting, and nominal GDP targeting] are without challenges and we will need to evaluate whether the net benefits of any of the alternatives would outweigh those of the flexible inflation-targeting framework currently in use in the U.S.” (1/5). She later (1/17) suggested linking individual policymakers’ rates and macro projections as a way to clarify the FOMC’s communication. Dudley (1/18) seemed opposed to the idea of raising the inflation objective but cited price-level targeting as worthy of consideration, despite its complications. Bullard (1/4) suggested that “One could tie private-sector expectations down still further by credibly committing to a monetary policy rule, such as a Taylor-type rule.”