Federal Reserve Governor Lael Brainard said the U.S. central bank needs to pay careful attention to underlying inflation before raising interest rates again, as longer-run price pressure trends appear to be lower.
“My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target,” Brainard said in a speech at The Economic Club of New York on Tuesday. If inflation continues to fall short of the central bank’s 2 percent target, “it would be prudent to raise the federal funds rate more gradually.”
Inflation has missed the Fed’s 2 percent target for most of the past five years and is currently showing inertia at low levels even as the economy continues to grow. Brainard said underlying inflation may be stuck in a lower trend after the financial crisis. Higher rates of resource use, and central bank signaling about tolerance for some overshoot of the inflation target, may be required to push trend prices higher. Brainard also said conditions have been met to begin running off the Fed’s balance sheet.
“It could take a considerable undershooting of the natural rate of unemployment to achieve our inflation objective if we were to rely on resource utilization alone,” she said. “I believe it is important to be clear that we would be comfortable with inflation moving modestly above our target for a time.”
U.S. central bankers have raised the benchmark lending rate twice this year to a target range of 1 percent to 1.25 percent. In June, they forecast a third increase in 2017. Financial markets are assigning a roughly one-in-three probability of another hike by year-end.
Brainard argued for a wait-and-see approach before raising rates again.
“The persistence of the shortfall in inflation from our objective should be one of the considerations in setting monetary policy,” she said. “Most immediately, we should assess inflation developments closely before making a determination on further adjustments to the federal funds rate.”
Brainard said the Federal Open Market Committee should allow the balance sheet to run off in the background, an event that is anticipated to start this year. However, she noted that if term premia on longer-run Treasuries rise as a result, that could also imply a lower target for the short-run rate needed to keep supply and demand in balance in the economy.
The Fed governor said it’s important to remain “vigilant” for signs of bubbles in a period of low rates and sustained economic growth, “especially in areas such as commercial real estate and corporate bonds, as well as the exceptionally low levels of expected volatility.”
Non-farm payrolls rose by 156,000 last month while the unemployment rate rose to 4.4 percent, remaining below the estimate of full employment for most Fed officials. Manufacturing jobs advanced by 36,000 last month, the largest gain since March 2012.
Meanwhile, the University of Michigan’s consumer sentiment survey showed Americans in the first eight months of this year have been more upbeat than at any comparable period since 2000. Households are growing increasingly optimistic about employment and the economic outlook, a positive sign for spending.
“Overall, the U.S. economy remains on solid footing, against the backdrop of the first synchronized global economic growth we have seen in many years and accommodative financial conditions,” she said.
Brainard said the economic effects of Hurricane Harvey “raise uncertainties about the economic outlook for the remainder of the year.”
“Based on past experience, it appears likely that the hurricane will have a notable effect on GDP in the current quarter, although output is likely to rebound by the end of the year,” she said. The hurricane that slammed into Texas disrupted oil production and refining capacity, boosting gas prices. That increase “should be short lived, but this outcome is uncertain and will depend on the extent of damage to refining capacity,” she said.