WASHINGTON (Reuters) - The U.S. Federal Reserve needs to be “especially” focused on incoming economic data in the current era and less tied to predictions that may lead it to a mistake, Fed vice chair Richard Clarida said on Thursday.
In comments that suggested the Fed will need to see solid evidence of higher inflation before raising interest rates again, Clarida said central bankers should be particularly sensitive to the limitations of their economic models - and not, for example, rush to judgment if those models were to forecast a jump in the level of price increases.
“We need...to be cognizant of the balance...between being forward looking, and maximizing the odds of being right given the reality that the models that we consult are not infallible,” Clarida said in remarks at a National Association for Business Economics conference.
His remarks shed light on what the Fed means by its “patient” approach to policy, adopted at the central bank’s January meeting. The new stance signaled a pause, and possible halt, to a monetary tightening cycle that saw nine rate increases since Dec. 2015, including four last year.
Because of the amount of time it takes for the economy to feel changes in interest rates, the Fed is to some degree bound by its forecasts and obliged to stay “ahead of the curve” on expected changes to the economy, particularly inflation.
But Clarida’s comments suggest a deeply cautious stance now that interest rates are at or near the level of rates considered to have a “neutral” impact that neither encourages nor discourages spending and investment.
The risk of tightening rates unnecessarily, curbing a 10-year recovery without cause, is now greater than the risk inflation may unexpectedly spike, Clarida said.
“Were a model to predict a surge in inflation, a decision for preemptive hikes before the surge is evident in actual data would need to be balanced against the considerable cost of the model being wrong,” he said. “Given muted inflation and stable inflation expectations, I believe we can be patient and allow the data to flow in.”
In a question and answer session he said recent wage gains, for example, showed no sign of translating into price increases. He compared the current situation to the mid-1990s, when a rising share of economic output went to workers but inflation remained tame.
“Our job is price inflation. If that scenario plays out we would not necessarily assume,” that rising pay for workers means inflation is close, he said. Currently “wage gains are in line with underlying inflation trends and underlying productivity.”
Clarida said that while the U.S. is “as close as it has been in many years” to meeting the Fed’s full employment and stable, 2 percent inflation goals, inflation indicators are “at the lower end” of the levels likely consistent with meeting that goal.
Clarida spoke before the release of fourth quarter GDP figures, but restated the Fed expects economic growth to slow in 2019. Gross domestic product increased at a 2.6 percent annualized rate in the fourth quarter, the Commerce Department said, after expanding at a 3.4 percent pace in the July-September period.
Reporting by Howard Schneider; Editing by Chizu Nomiyama