While everybody watches the Federal Reserve with bated breath, anticipating a rate hike sooner or later but most likely later this year, the president of the Boston Federal Reserve Bank this week warned: This time will not be like the last time.
Speaking before the Forecasters Club of New York on Tuesday, Eric Rosengren cited numerous reasons for his belief that this normalization process would happen much more slowly than the last two tightening cycles, in 1994 and 2004.
“While market attention has focused on the exact timing of potential rate rises, macroeconomic models of the economy overwhelmingly suggest little impact on the broader economic landscape from moving the timing of initial interest rate hikes forward or backward by a couple of months,” Rosengren said, according to prepared remarks. “However, the future trajectory of interest rate increases – that is, whether increases to more normalized levels occur quickly or more gradually – is, by contrast, likely to have a meaningful impact on employment and inflation.”
In the past two tightening cycles, the federal funds rate increased rapidly, Rosengren said. In 1994, for example, the federal funds rate increased about 250 basis points in the span of a year. In June 2004, when the Federal Open Markets Committee began the most recent tightening cycle, the committee raised rates by 25 basis points at each of the next eight meetings, totaling an increase of about 200 basis points over the next year.
But in both of those past tightening cycles, the core personal consumption expenditures index was either somewhat above or very nearly at the 2 percent benchmark that the committee has reiterated it would like to see before raising rates.
Furthermore, real GDP growth over the past four quarters has averaged just 2.7 percent, compared with 3.4 percent at the start of the 1994 tightening cycle and 4.2 percent in 2004.
Finally, while unemployment figures are lower than in past tightening cycles, the picture changes when you take into account a broader definition of unemployment, which would include those workers who are part-time or “marginally attached to the workforce.” That unemployment rate, referred to as the U-6 rate, stood at 10.4 percent in July, between the 11.5 percent U-6 rate that preceded the 1994 tightening cycle and the 9.6 percent in 2004.
“In my own view, given current and forecast conditions, not only is the pace likely to be gradual, but the federal funds rate in the longer run may be lower than in previous tightening cycles,” Rosengren said.
He concluded, “The more gradual tightening cycle should enable monetary policymakers to gauge how tight labor markets can be while maintaining stable prices. The very low inflation rates here and abroad make it a particularly good time to not be too tied to imprecise measures of full employment.”
