Further US tightening risks recession – St Louis Fed president

The Federal Reserve would increase the risk of recession if it carried on raising interest rates according to its current projection, the St. Louis Fed president said.

“The current level of the policy rate is about right over the forecast horizon,” James Bullard said in a speech on October 18. “Interest rates don’t have to go anywhere.”

The Fed currently projects interest rates to rise to around 3.4% by 2020. A rate that high is “quite a way into restrictive territory”, Bullard argued. Bullard is an alternate Federal Open Market Committee (FOMC) member this year

Bullard, said he has been “willing to go along” with the rate rises because the economy “keep surprising to the upside”.

In the speech Bullard proposed a “modernised” monetary rule, adapting the Taylor Rule. He said his proposed adjustments would account for “important macroeconomic developments” that have happened in recent decades.

Bullard’s monetary rule suggests the Fed should not “pencil in” a rate increase for the next FOMC meeting on November 7–8. It calls for a more “subdued” path over the horizon, he said.

Bullard dismissed concerns that the US economy is over-heating. He said asset bubbles are being controlled by the “beefed up” regulatory system and the Fed should not have to use monetary policy in order to contain them.  

He also rejected the argument that inflation is “just around the corner” because of low unemployment causing wage pressure. The feedback from the real economy to inflation today is weaker than it used to be, he argued.

November 7–8 voting members

In contrast to Bullard, new FOMC member Mary Daly said she is in favour of the Fed’s gradual pace of normalisation. 

In her first speech since becoming San Francisco Fed president, she cited “exceptionally rapid” GDP growth, a booming labour market, and inflation that is back at the Fed’s 2% target. None the less, she said the Fed must still try to “strike the right” balance to avoid moving rates up too quickly and tipping the economy into recession.

Atlanta Fed president and voting FOMC member Raphael Bostic also made a hawkish speech.

In a speech on October 5, Bostic said the incoming data from the real economy is “much stronger” than he had expected. He raised concerns that the strong US GDP and job growth may be signalling that economists have underestimated the underlying momentum of aggregate demand.

“If that’s the case, the potential for overheating would require a higher path for rates than what I had been thinking,” he said.

Vice chairman for supervision Randal Quarles also supported carrying on with the  Fed’s outlined path of monetary tightening. The positive economic situation “reinforces and supports the importance of a clear, steady strategy and a gradual, predictable approach to the removal of accommodation”, he said in a speech on October 18.