Dudley Foresees Need for Fed Rate Hikes to Slow the U.S. Economy

(Bloomberg) -- The Federal Reserve will probably have to raise interest rates in the years ahead above levels officials consider neutral for the U.S. economy because of how far the unemployment rate has fallen, outgoing New York Fed President William Dudley said.

“The federal funds rate will probably have to climb a little bit above neutral, because the unemployment rate is already -- from most people’s vantage points -- below a sustainable level of unemployment consistent with stable inflation,” Dudley told reporters Friday. “So, I think the move will be eventually to a slightly tight monetary policy.”

Dudley, 65, is retiring after 10 years at the helm of the New York Fed. His replacement, current San Francisco Fed chief John Williams, takes over on Monday. The U.S. central bank raised interest rates this week and signaled two more increases in 2018, while forecasting it would nudge rates above neutral by the end of 2019.

“I’m sort of expecting that the peak in the federal funds rate in this cycle will be lower than in past cycles, but I have quite a bit of uncertainty about that,” Dudley said during a conference call.

Taxes, Spending

Tax cuts and federal spending increases signed by President Donald Trump “are going to add a lot of stimulus to the economy in ‘18, ‘19, and I think it’s probably going to go all the way into 2020, so that could also affect exactly what the trajectory of rates are, and how high rates have to go,” he added.

Dudley defended the need for tighter monetary policy after Fed Chairman Jerome Powell faced questions on the topic Wednesday during a press conference following the Fed’s decision to raise rates for the second time this year.

“The problem is trying to generate a sustained high level of employment, and the way you keep employment at a high level on a sustained basis is you keep inflation in check,” Dudley said. “So, inflation in check is sort of a necessary condition to keep the economy in a position where it can actually keep employment at a high level.”

The New York Fed chief deflected criticism from Reserve Bank of India Governor Urjit Patel, who wrote in a June 3 Financial Times op-ed that the Fed should slow down the unwind of its balance sheet because it is contributing to financial-market turmoil in emerging economies.

‘Some Spillover’

“There has been some spillover, potentially, to emerging-market economies, but again, it’s also hard to sort of say how much of that is due to the normalization of the balance sheet versus other factors,” Dudley said.

He cited large fiscal and current account deficits in many emerging markets, which he said “probably would have been problematic in any case, so sort of laying this all at the feet of the balance sheet normalization process, I think, is probably going a little bit too far.”

Dudley also warned that politicians should respect the tradition of independence granted to central bankers over interest-rate decisions.

“It’s been pretty well accepted in the U.S. that letting the Fed have independence with respect to the day-to-day conduct of monetary policy does lead to better economic outcomes, and I think that’s something that is in interest both of the Federal Reserve, and it’s also in the interest of Congress and the administration.”

©2018 Bloomberg L.P.