Fed’s Fischer sees inflation rebound, allowing gradual rate hikes | Reuters

31 Aug 2015 | Author: | No comments yet »

Fed Vice Chair Fischer keeps open possibility of Sept. hike.

JACKSON HOLE: The Federal Reserve on Friday left the door open to a September interest rate hike even while several US central bank officials acknowledged that turmoil in financial markets, if prolonged, could delay the first policy tightening in nearly a decade.The following is a reformatted version of prepared remarks by Federal Reserve Vice Chairman Stanley Fischer at the Kansas City Fed’s annual retreat in Jackson Hole, Wyoming. The comments, uncoordinated but generally consistent, suggested that some investors and analysts had been too quick to discount a September rate increase, particularly as global markets finished last week on a relatively quiet note. “We haven’t made a decision yet, and I don’t think we should,” Fed vice-chairman Stanley Fischer said in an interview with CNBC. “We’ve got time to wait and see the incoming data and see what exactly is going on now in the economy.” The Fed’s policymaking committee is slated to meet on Sept 16 and 17. Fischer said there’s “good reason to believe that inflation will move higher as the forces holding down inflation dissipate further.” He said, for example, that some effects of a stronger dollar and a plunge in oil prices — key factors in holding down inflation — have already started to diminish.

Although the economy has continued to recover and the labor market is approaching our maximum employment objective, inflation has been persistently below 2 percent. He described job growth as “impressive” and said there had been a “pretty strong case” to raise rates in September before the latest round of global turmoil. And so if any consensus had emerged, it would already have been communicated to the market, said former Fed Vice Chairman Alan Blinder. “If they knew, they’d already be giving strong hints. US stock indexes ended largely unchanged, capping a week that included both the market’s worst day in four years and biggest two-day gain since the 2007-2009 financial crisis.

As a result, 12-month changes in the overall personal consumption expenditure (PCE) price index have recently been only a little above zero (chart 1). Louis Fed President James Bullard told Reuters he still favored hiking rates next month, though he added that his colleagues would be hesitant to do so if global markets continued to be volatile in mid-September.

Michael Hanson, senior economist at Bank of America Merrill Lynch, saw Fischer’s remarks as an explanation of why the Fed might not wait for inflation to move closer to 2 percent before raising rates. The wild ride in the U.S. equity market — as volatility returned to levels not seen in five years — cast a pall over the deliberations at the resort at the base of the Grand Tetons.

John Silvia, chief economist at Wells Fargo, said that based on Fischer’s comments, he thinks the first rate hike will come next month if the August jobs report that will arrive Friday is strong and financial markets settle down. But measures of core inflation, which are intended to help us look through such transitory price movements, have also been relatively low (return to chart 1). Instead, he argued, the central bank should consider expanding its stimulus campaign to address the persistence of low inflation, which can harm consumer spending and business plans for expansion.

He repeated the guidelines the Fed is using to determine when to raise its key short-term rate, which has been held near zero since 2008 and has helped keep borrowing rates low throughout the economy. The US government reported this week that the economy grew at a 3.7 percent annualized pace in the second quarter, sharply higher than its previous estimate, and that consumer spending, which accounts for more than two-thirds of economic activity, rose again in July. On the other hand, doves of the Fed think the market volatility is a sign that inflation is going to remain low and there is no reason to rush in and increase.

But after Fischer spoke, traders added to bets that a rate hike would come this year, with overnight indexed swap rates implying a 35 percent chance the Fed would move in September and a 77 percent chance of a December move. Fischer said on Saturday, “which are due to be published on Sept. 4.” As for inflation, the Fed has said repeatedly that it will act based not on observed inflation but instead on its expectations for future inflation.

Moreover, note that core inflation does not entirely “exclude” food and energy, because changes in energy prices affect firms’ costs and so can pass into prices of non-energy items. One idea appearing to gain ground on Friday hinged on the Fed raising rates once or twice and then holding off until inflation started to rise to its 2 percent target. The Fed’s preferred measure of inflation shows that prices rose 0.3 percent during the 12 months ending in July, well below the 2 percent annual pace the Fed considers healthy. On average, CPI inflation tends to run a few tenths higher than PCE inflation, and, because the CPI has a modestly larger weight on energy prices, fluctuations in the CPI measure tend to be a bit larger. The Fed decision has drawn unusually intense interest from both foreign central bankers, who will have to respond, and from Americans on both the right and left.

Even so, with inflation expectations apparently stable, we would have expected the gradual reduction of slack to be associated with less downward price pressure. The Fed needs to re-think “full employment in a way that recognizes the high joblessness of black and Latino communities,” Sarita Turner of PolicyLink told about 60 advocates, noting that US joblessness among blacks is twice that of whites.

This fact helps drive home an important point: While much evidence points to at least some ongoing role for slack in helping to explain movements in inflation, this influence is typically estimated to be modest in magnitude, and can easily be masked by other factors.2 In the first instance, as already noted, core inflation can to some extent be influenced by oil prices. A higher value of the dollar passes through to lower import prices, which hold down U.S. inflation both because imports make up part of final consumption, and because lower prices for imported components hold down business costs more generally. In addition, a rise in the dollar restrains the growth of aggregate demand and overall economic activity, and so has some effect on inflation through that more indirect channel.3 To get a sense of the timing and magnitude of these exchange rate effects, chart 5 shows dynamic simulations of a 10 percent real dollar appreciation, based on one of the models we maintain at the Federal Reserve.4 The estimated pass-through from import prices to consumer price inflation occurs relatively quickly, with effects becoming evident within a quarter and the bulk of the overall effect occurring within one year. Prices of metals and other industrial commodities, and agricultural products, are affected to a considerable extent by developments outside the United States, and the softness we’ve seen in these commodity prices, has in part reflected a slowing of demand from China and elsewhere.

Thus, the stability of inflation expectations has prevented inflation from falling further below our objective than occurred, and it has enabled the Federal Open Market Committee to look through some upward inflation shocks without compromising price stability.5 We should however be cautious in our assessment that inflation expectations are remaining stable. But these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations, such as changes in demand for the unparalleled liquidity of nominal Treasury securities.

In determining how long to maintain this target range, the Committee will assess progress–both realized and expected– toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

In addition, with regard to expectations of inflation, it is possible to consult the results of the SEP, the Survey of Economic Projections, which FOMC participants complete shortly before the March, June, September, and December meetings. In the June SEP, the central tendency of FOMC participants’ projections for core PCE inflation was 1.3 percent to 1.4 percent this year, 1.6 percent to 1.9 percent next year, and 1.9 percent to 2.0 percent in 2017.

In addition, the July announcement set a condition of requiring ‘‘some further improvement in the labor market.” From May through July, non-farm payroll employment gains have averaged 235,000 per month. Of course, the FOMC’s monetary policy decision is not a mechanical one, based purely on the set of numbers reported in the payroll survey and in our judgment on the degree of confidence members of the committee have about future inflation.

In the case of the core rate of inflation, we are mainly looking for a good indicator of future inflation, and for better indicators than we have at present. At this moment, we are following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual. Among the many papers finding a role for resource utilization in affecting inflation based on evidence from macroeconomic time-series data, see Robert J. Gordon (2013), “The Phillips Curve Is Alive and Well: Inflation and the NAIRU during the Slow Recovery (PDF),” Leaving the Board NBER Working Paper Series 19390 (Cambridge, Mass.: National Bureau of Economic Research, August); or Douglas O. There has also been debate regarding other potential channels through which global factors could affect domestic inflation– for example, whether measures of foreign resource utilization play an important independent role.

This model incorporates monetary policy responses to economic shocks and thus may show smaller effects on real GDP and inflation than other partial-equilibrium analyses. It is noteworthy that in several inflation-targeting economies, the ten year expected inflation rate has settled precisely at the target inflation rate. For more discussion on this theme, see Stanley Fischer (2014), “The Federal Reserve and the Global Economy,” speech delivered at the 2014 Annual Meetings of the International Monetary Fund and the World Bank Group, Washington, October 11.

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