Central bankers at last month’s policy meeting believed the economy would run hot for the next few years
Federal Reserve officials at their meeting last month expressed greater confidence inflation would rise to their 2% target over the coming year, a development that could affect how much they raise interest rates in coming years.
They also debated the costs and benefits of allowing the economy to run hot and discussed how they might need to later raise rates to a level that would deliberately slow growth, according to minutes of their March 20-21 meeting, which were released Wednesday.
The minutes highlight just how much Fed officials’ outlook has changed since last fall, when surprisingly slow inflation raised questions about the need for continued rate increases.
Fed officials last month believed the economy would run hot, or grow faster than its sustainable rate, for the next few years, the minutes said.
In March, “all participants agreed that the outlook for the economy beyond the current quarter had strengthened in recent months,” the minutes said. In addition, “all participants expected inflation on a 12-month basis to move up in coming months.”
The outlook has shifted since late last year because Congress and the White House approved tax cuts and a boost in federal government spending for this year and next. The economy hasn’t often had such fiscal stimulus when unemployment is so low.
Last year, falling unemployment supported the case for rate increases. The jobless rate has held at 4.1% since last October, near an 18-year low.
But inflation pressures softened last year, bolstering arguments in favor of slowing the pace of rate rises. At the time, top Fed officials said they expected the slowdown would prove transitory, and inflation pressures have firmed up in recent months.
Officials noted the potential benefits of letting the economy run hot, such as drawing more Americans into the workforce from the sidelines and speeding inflation’s return toward the central bank’s 2% goal. The policy makers also noted potential costs: “An overheated economy could result in significant inflation pressure or lead to financial instability,” the minutes said.
The Fed seeks to keep inflation at 2% because it views that level as consistent with an economy with healthy demand for goods and services.
At the same time, some officials warned they eventually could need to lift rates to a level that would deliberately restrict growth.
Some officials said they might need to acknowledge in future postmeeting policy statements that interest rates eventually would rise from a low level that spurs growth “to being a neutral or restraining factor for economic activity,” the minutes said.
After holding its benchmark federal-funds rate near zero for seven years, the Fed has raised it six times since late 2015, most recently last month to a range between 1.5% and 1.75%. Officials also penciled in two more quarter-percentage-point rate increases in 2018 and three such moves in 2019.
The Fed isn’t likely to raise rates at its next meeting, May 1-2, but investors largely expect another quarter-percentage-point increase at the following meeting in June. Investors have focused more attention on whether the Fed will feel pressure to add a fourth rate increase this year. The answer largely turns on inflation.
Of the 15 Fed officials at March’s meeting, 12 penciled in either three or four rate increases for 2018, and they were equally divided between those two paths. Most officials also penciled in at least three rate increases for 2019.
If Fed officials grow more confident that inflation is rising toward their 2% target over time, they could stick to their tentative plan for three rate increases this year. But if it looks like new federal spending, tax cuts, a weaker dollar and lower unemployment will lead to an acceleration in price pressures, policy makers could act more aggressively.
Consumer prices excluding volatile food and energy items rose 2.1% in March from a year earlier, according to the so-called core consumer-price index, released by the Labor Department Wednesday. That was the strongest reading since February 2017.
Economists at JPMorgan Chase estimate the Fed’s preferred inflation gauge, produced by the Commerce Department, will show annual core inflation of 1.9% in March when it is released later this month. In February, it was 1.6%.
Annual inflation is expected to rise in coming months because the weak monthly readings of last March and April will no longer be included in year-over-year comparisons, the minutes said.
This upturn is “widely expected and, by itself, would not justify a change in the projected path for the federal-funds rate,” the minutes said.
While the minutes show Fed officials are optimistic about economic growth, the prospect of trade fights loomed as one significant concern.
“A strong majority” of Fed officials saw the prospect of retaliatory trade actions by other countries as a risk for the U.S. economy, the minutes said. Officials’ contacts in the agriculture industry reported “feeling particularly vulnerable to retaliation.”
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