India’s Rajan Says Reserve Bank Is in an ‘Accommodative’ Policy Phase

30 Aug 2015 | Author: | No comments yet »

Fed vice-chairman hints at interest rate increase in speech on inflation.

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.Stronger growth will pull inflation higher in the U.S. and Europe, according to three top central bankers who voiced confidence that their regions will escape from headwinds that are keeping inflation too low.Federal Reserve vice-chairman Stanley Fischer left the door open Saturday for a Fed rate increase in September, saying the factors that have kept inflation below the central bank’s target level have likely begun to fade.

I will focus my remarks today on forces–domestic and international–that have been holding down inflation in the United States,1 and some of the consequences of recent– primarily international–developments. Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said it suggested that Fischer wants to get going on rate hikes. “It sounds like Fed Vice Chairman Fischer is getting an itchy trigger finger when it comes to lifting rates,” he said in a note to clients. “Today’s news represents an important change possibly in the leadership of the Fed’s position, which clears the way for action on Sept. 17.” Rupkey is among economists who have said that, with unemployment at 5.3 percent, close to what the Fed considers full employment, it is time for a rate increase. The remarks, delivered at an annual conference hosted by the Federal Reserve Bank of Kansas City, reinforced other recent indications that the Fed remained on course to raise interest rates this year. Although the economy has continued to recover and the labor market is approaching our maximum employment objective, inflation has been persistently below 2 percent.

In his prepared remarks, Fischer stopped short of providing a clear signal on whether the Federal Open Market Committee will start to tighten policy at its next scheduled meeting Sept. 16-17. “We will need to consider all the available information and assess its implications for the economic outlook before coming to a judgment,” he said. That has been especially true recently, as the drop in oil prices over the past year, on the order of about 60 percent, has led directly to lower inflation as it feeds through to lower prices of gasoline and other energy items. 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). The central bank slashed its target interest rate to zero during the depths of the financial crisis in 2008 and has left it there ever since in hopes of fostering a stronger recovery. His remarks on Saturday were highly anticipated after days of turmoil in financial markets that raised questions about whether the Fed’s plans had changed.

Five-year, five-year inflation swaps in the euro area — which reflect expectations for the five-year path of inflation five years from now — show that market-based inflation expectations slid to about 1.65 percent in August from about 1.85 percent at the beginning of the month. Probabilities of a rate move at next month’s FOMC meeting were 38 percent at New York’s close on Friday, down from 48 percent on Aug. 14, according to trading in federal funds futures. 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). 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. Government data released Friday showed prices, excluding food and energy, rose just 1.2 percent compared to a year ago — well below the Fed’s goal.

Still, “these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations.” Fed Chair Janet Yellen and ECB President Mario Draghi both skipped the Jackson Hole event this year. Policy makers, who have held rates near zero since 2008, must judge if the U.S. economy has sufficient momentum to shrug off weaker growth abroad as they weigh the timing of liftoff. A dimmer outlook for world growth has pushed commodity prices lower, potentially creating another headwind for feeble U.S. inflation, which has been beneath the Fed’s 2 percent target for more than three years. The next week, the Labor Department announced that the economy had added an estimated 215,000 jobs in July. “We now await the results of the August employment survey,” Mr.

On the other hand, U.S. gross domestic product growth was better than expected in the second quarter at a 3.7 percent annualized rate, and monthly job gains have averaged a solid 211,000 so far this year. 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. In the U.K., Bank of England Governor Mark Carney said “the prospect of sustained momentum” in the economy and a gradual pickup in inflationary pressures “will likely put the decision as to when to start the process of gradual monetary policy normalization into sharper relief around the turn of this year.” He said “recent events” including China’s slowdown so far don’t call for changing the BOE’s strategy for returning inflation to target.

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. William Dudley, president of the New York Federal Reserve, helped ignite a Wall Street rally this week when he told reporters that the case for raising rates in September was “less compelling to me” that it had been a few weeks ago, before sudden fears about China’s economy upset global markets. Even so, with inflation expectations apparently stable, we would have expected the gradual reduction of slack to be associated with less downward price pressure. Fed models show a 10 percent spike in the greenback pushes down inflation over the same year as the rise but reduces economic growth in the following year.

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. Fischer also called the recent decline in energy prices a “largely one-off event.” But other economists have questioned whether the Fed can achieve its target for inflation without providing more stimulus for the economy.

Officials say they are not inclined to act in the face of volatility, in part because they see little practical difference between moving in September and waiting a little longer. The rise in the dollar since last summer, of about 17 percent in nominal terms, with its associated declines in non-oil import prices, could plausibly be holding down core inflation quite noticeably this 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. 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 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. 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. While thinking of different aspects of unemployment, we are concerned mainly with trying to find the right measure of the difficulties caused to current and potential participants in the labor force by their unemployment.

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. By committing to foster the movement of inflation toward our 2 percent objective, we are enhancing the credibility of monetary policy and supporting the continued stability of inflation expectations. Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2 percent to begin tightening. 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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