The most noteworthy policy speech last week was Yellen’s remarks at Stanford. For our detailed perspective, click here for our discussion. Her speech reinforced our view that she currently sees three hikes as the appropriate pace for 2017. Once again she provided an optimistic assessment of the current state of the economy, progress made over recent years, and the economic outlook. She added that although the fundamentals of the economy are sound, “uncertainty is prevalent.”She leaned against running the economy hot, supporting withdrawing accommodation gradually, but less gradually than the several most-dovish FOMC participants have advocated. Williams echoed this view last week as well. Dudley was even more explicit than Yellen, warning that “If we pushed the unemployment rate much lower, we’d have an inflation problem.”
Other policymakers’ attitudes toward the appropriate pace of rate hikes was mostly as expected. Harker repeated that he saw “three modest hikes as appropriate for the coming year, assuming the economy stays on track.” He saw inflation as meeting 2 percent this year and the labor market as showing “positive overall trends,” but was concerned about the participation rate underperforming his expectations, nothing that the trend will likely stay low “due to demographics” and baby boomers, and warned that it “could drop up to 2 percentage points further over the next five years.” But he also said that solutions to this problem were likely legislative–that is, not monetary policy. For Williams, he saw global events as posing key downside risks to his outlook. Brainard espoused an upbeat view, noting that “the economy has made really nice progress over the past year toward full employment,” there are “reasons to think that consumer spending could remain robust,” and business investment is “ripe for some improvement.”
FOMC policymakers continued to view potential fiscal stimulus and new trade policies as tentative. Harker noted that “Right now it’s impossible for me to factor any of those into a forecast because I don’t know what those policies will be.” However, he warned that the current full-employment state of the labor market means “any large stimulus to the economy may run the risk of inflation growing faster than we hope.” He also cautioned of possible downside risks from potential new trade policies: “If we had a significant trade war, say with China, the lower 10% of the income distribution would lose 50% of their purchasing power.”
The headline from Brainard’s speech was her observation that fiscal stimulus could warrant a faster pace of rate hikes: “If fiscal policy changes lead to a more rapid elimination of slack, policy adjustment would, all else being equal, likely be more rapid than otherwise.” Yellen alluded to the potential impact of fiscal policy changes on normalization, noting that much is uncertain: “I would mention the potential for changes in fiscal policy to affect the economic outlook and the appropriate policy path. At this point, however, the size, timing, and composition of such changes remain uncertain. However, as this discussion highlights, the course of monetary policy over the next few years will depend on many different factors, of which fiscal policy is just one.” She continued to emphasize that policy would be set to fulfill the dual mandate.
Kashkari held a dim view of the market’s ability to foresee political outcomes: “markets are notoriously bad at predicting political outcomes. Markets didn’t predict Brexit, they didn’t predict the presidential election…I have no greater confidence that markets can tell us exactly what the new Congress and the new administration are going to do, and so I want to see a lot more information before that really changes my perspective.” Kaplan sounded more optimistic about the prospective fiscal stimulus: stronger growth “would allow the Fed to more quickly normalize rates.” Yellen only revealed that “we are at a point when many economic policy changes are under consideration, and of course we will closely follow that.” She also expected the drag on exports from a stronger dollar to continue. Dudley was particularly concerned about the border adjustment, which he said “would lead to dramatic changes in the value of the dollar.” He desired to see a proposal that was “a little bit less dramatic.”
Balance sheet reinvestment policy continued to emerge as a topic of interest. Williams expected any changes to be telegraphed well enough that when beginning runoff “won’t be disruptive at all.” He added, “it will cause interest rates to go up,” which is “desirable…There are no surprises in terms of how that’s going to happen.” Harker repeated his view that a funds rate at 1 percent could be a threshold for considering to stop reinvestment: “We are actively discussing and researching the question of what is the appropriate size in the long run…Again, that process will take years to create whatever the new normal is with respect to the balance sheet. We have some time to think that through.” Kaplan saw late 2017 or early 2018 as an appropriate time to revisit the balance sheet: “We should be removing accommodation, probably sometime later in this year, early next year, looking at the Fed balance sheet in order to examine how we might let that run off or reduce it.” Kashkari noted that it might be too soon to contemplate future directions for the balance sheet: “We need a lot more information, in my mind, before we can make any forecasts about what it would mean for the balance sheet.” Brainard’s optimistic view on fiscal stimulus translated into a sooner runoff of the balance sheet; “If fiscal policy changes lead to a more rapid elimination of slack, policy adjustment would, all else being equal, likely be more rapid than otherwise, with the conditions the FOMC has set for a cessation of reinvestments of principal payments on existing securities holdings being met sooner than they otherwise would have been.”
Yellen continued to stand opposed to proposals to regulate FOMC policymaking via the imposition of a statutory policy rule, saying it “really interferes with the independence of monetary policy.” She also defended the dual mandate. Williams reiterated that the FOMC is nonpartisan: “when you have a change of administration and that happens, it’s still the case that you have a lot of continuity in policy making.” He added, “what I really care about is maintaining the independence that we have.”