Speaking before the Annual Rocky Mountain Economic Summit in Idaho last week, Boston Federal Reserve President and CEO Eric Rosengren cautioned against “simple and unqualified” forecasts about monetary policy and highlighted several areas of uncertainty that could give the Fed pause before raising short-term interest rates.
“Were the U.S. economy to unfold as I and other policymakers expected in our June [Summary of Economic Predictions] forecasts, beginning the policy normalization process later this year might be appropriate. However, the assumption that our current forecasts for labor markets and for inflation will unfold as expected is still subject to considerable uncertainty,” Rosengren said, according to prepared remarks.
Inflation persists below the Fed’s 2 percent target stipulated for raising short-term rates, he said.
“Inflation rates that are too low limit monetary policy’s ability to offset the disturbances that often buffet an economy,” he said, noting that “the undershooting of inflation targets has been a problem in many developed countries.”
Rosengren also noted that Federal Open Markets Committee (FOMC) participants in late 2012 and early 2013 largely expected to see 2 percent inflation this year, but those forecasts have grown increasingly pessimistic as core personal consumption expenditure inflation has hovered around 1.2 percent for the past year. The June forecasts for later this year showed a central tendency of 1.3 or 1.4 percent, he said.
“One reason the inflation rate may be so subdued is that significant slack – that is, excess supply – may remain in the labor market despite the simplest and most widely reported unemployment rate having fallen to 5.3 percent,” he said.
Rosengren put that down partly to demographics: The percentage of younger Americans in 2014 fell relative to the percentage of Americans in those age groups in 1994, yet more Americans in older age cohorts are also working than ever before. Therefore, the unemployment rate might better reflect “full employment” at a lower figure and Rosengren had accordingly adjusted his own estimate of the natural rate of employment to 5 percent.
If inflation continues to undershoot the FOMC’s forecasts, he said, that figure might need to be revised still downward.
Furthermore, events abroad – such as Greece’s debt crisis, China’s slowing economy and Japan’s economic challenges – could also disrupt the U.S. economy.
While Rosengren expressed hope that those key risks would resolve in a way that supports the FOMC’s normalization criteria, he stressed the need for monetary policy to be data dependent as the Fed nears its dual mandate goals.
“[Data] dependence at this point means, in my view, that we wait for data that gives us greater confidence in our forecast, especially our forecast for inflation. And it also means we wait to get a better handle on how the crisis in Greece gets resolved, so that we can better gauge its potential to impact financial markets and the domestic economy,” he said.
