Williams Calls For Gradual Hikes Amid Strong Growth Outlook

(Bloomberg) -- Federal Reserve Bank of New York President John Williams called for continued gradual rate increases as a strong U.S. economy pushes unemployment close to a half-century low.

In his first full policy speech since moving to New York from the San Francisco Fed, Williams downplayed the guiding power of the neutral rate -- the one that divides tight and easy policy, and a concept on which he is a leading expert. He also explained why the central bank is removing forward guidance as policy creeps toward a more normal setting.

“At some point in the future, it will no longer be clear whether interest rates need to go up or down, and explicit forward guidance about the future path of policy will no longer be appropriate,” Williams said Friday in remarks prepared for delivery at a Columbia University conference in New York.

Williams’ comments come two days after the Fed made its third rate increase this year, and at a time when unemployment is at 3.9 percent and inflation is coming in right around the Fed’s 2 percent goal. Fed officials project future rate increases, and markets are watching closely for any hint at how fast and how far they will hike in 2019 and beyond.

“The path of interest rates will continue to be guided strategically by our dual mandate objectives and shaped tactically by the data and their implications for the economic outlook,” according to Williams, who as New York Fed president has a permanent vote on the Federal Open Market Committee. He also said that “from the perspective of the Fed’s dual mandate of maximum employment and price stability, quite honestly, this is about as good as it gets.”

Williams said he sees real gross domestic product increasing by 3 percent in 2018 and by 2.5 percent in 2019. He sees the unemployment rate falling “slightly below” 3.5 percent next year, and expects inflation just above 2 percent without “any signs of greater inflationary pressures on the horizon.”

Neutral Rate

Fed watchers have been paying close attention to the central bank’s projection for the interest rate that will prevail in the longer run, because it’s seen as a proxy for whether the central bank will run restrictive policy. Fed Chairman Jerome Powell has de-emphasized those uncertain estimates of the neutral rate, often called r-star. Williams -- co-author of one of the most widely used r-star models -- added his voice to that chorus.

“At times r-star has actually gotten too much attention in commentary about Fed policy,” Williams said. “As we have gotten closer to the range of estimates of neutral, what appeared to be a bright point of light is really a fuzzy blur.”

The New York Fed chief also supported the Fed’s current operating framework for setting its interest rate range.

In the depths of the financial crisis, the U.S. central bank began setting a target range for its benchmark federal funds rate, instead of a single rate level. It also switched the mechanism it uses to ensure the rate stays within that band.

Called the “floor” system, the still-intact framework has treated the interest the Fed pays banks for excess reserves as an upper bound of the target range. The pre-crisis approach -- known as the “corridor’’ -- was predicated on maintaining scarce reserves and then draining or adding supply to guide fed funds toward a single rate.

Floor, Corridor

The Fed hasn’t said when it will decide if it plans to stick with the floor system or go back to the corridor, but many Fed officials argue the floor mechanism gives policy makers more flexibility and would allow them to more easily return to bond purchases if the economy needed the extra boost. Which operating system the Fed chooses will ultimately inform the size of its balance sheet.

“This approach is working very well at controlling interest rates and has proven to be easy to communicate and adaptable,” Williams said Friday. “The Fed will be looking closely at these options in the coming months and will subsequently make a decision on the future operating framework.”

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