MINNEAPOLIS, May 15 (Reuters) - Continued U.S. economic growth and a positive outlook have done nothing to raise the underlying neutral rate of interest, San Francisco Federal Reserve President John Williams said in remarks on Tuesday that highlight an intensifying debate at the central bank over how high rates might rise in its move to “normalize” monetary policy.
At issue are varying estimates of the neutral rate of interest, and whether current stronger growth may lift it, as Fed vice chair for financial supervision Randal Quarles and some others have recently suggested.
Williams, about to also assume a vice chairmanship as head of the New York Fed, said in remarks to the Economic Club of Minnesota that he thought such optimism was “misplaced,” and that the neutral rate remained mired at around 2.5 percent by long-term forces like an aging population and global demand for safe assets.
The neutral rate is a level of interest that is seen as neither encouraging nor discouraging economic decisions, and is consistent with both stable inflation and strong employment.
The Fed’s benchmark rate would approach 2.5 percent after just three more rate increases, perhaps even by the end of this year, forcing the Fed to acknowledge the decade-long era of “accommodative” policy had ended, recast its policy statement accordingly, and provide some sense of what happens next.
Williams said he agreed that continued rate increases were “the right direction for monetary policy,” but that he sees no evidence the neutral rate is rising despite a positive outlook and “tailwinds” including fiscal policy that may mean stronger growth.
“Even as we raise rates, I’m conscious that the fundamental drivers that govern r-star (the neutral rate) are lower than we’ve seen in the past. With a new normal for short-term rates of around 2.5 percent, interest rates are likely to remain low relative to historical experience,” he said.
Some consensus around the neutral rate is central to the Fed’s policymaking in the coming year, and will shape when the Fed signals to the public that the era of loose policy is over.
Williams has been among the most active of Fed policymakers in researching and developing methods to estimate the neutral rate.
As New York Fed president with a permanent vote on policy, his influence on the issue may well increase. Incoming vice chair Richard Clarida is also considered an expert on the topic.
“Some economists and central bankers have pointed to signs that the fortunes of r-star are set to rise,” Williams said. “I wish I could join in this optimism, but I don’t yet see convincing evidence.” (Reporting by Howard Schneider; Editing by Andrea Ricci)