St. Louis Fed's Bullard Addresses Five U.S. Macroeconomic Questions for 2017

NEW YORK – Federal Reserve Bank of St. Louis President James Bullard discussed “Five Macroeconomic Questions for 2017” at the Forecasters Club of New York on Thursday.

In his presentation, he explored some recent questions related to the St. Louis Fed’s regime-based approach to near-term U.S. macroeconomic and monetary policy projections. “Since the U.S. presidential election in November, we have entertained many questions on the regime-based view,” Bullard said.

He explained how the St. Louis Fed came to its decision in 2016 to move to a regime-based approach, under which the macroeconomy could visit a set of possible regimes and monetary policy would be regime-dependent.

Bullard said that this was, in part, a reaction to projections since 2012 by Federal Open Market Committee participants (including the St. Louis Fed) of a meaningfully rising policy rate over the forecast horizon, which continually did not materialize in the subsequent years. In effect, the Committee kept the policy rate lower than had previously been expected, without any detectable increase in inflation or additional economic growth, he noted.

Therefore, “in 2016, we at the St. Louis Fed concluded that the model behind this type of projection was questionable. We argued that a better view of the current U.S. macroeconomic environment is as a ‘low-safe-real-interest-rate regime,’” he said.

Bullard noted that monetary policy can then be thought of in terms of a Taylor-type interest rate rule conditional on this low-rate regime. “Because unemployment and inflation are close to target, there is presently little reason to change the policy rate given the regime,” he said. “Therefore, we have projected only a little movement in the policy rate over the forecast horizon.”

Meanwhile, several proposed policies of the incoming administration have raised the question of whether there may be a regime change afoot for the U.S. economy. Bullard proceeded to outline and discuss five related questions that have arisen.

Will the low-real-rate regime give way to a high-real-rate regime in the U.S. in 2017?

Bullard noted that the U.S. has experienced two real-interest-rate regimes in recent decades: the high-real-interest-rate regime that prevailed in the 1980s, the 1990s and into the 2000s, and the low-real-interest-rate regime that prevails today. He said it was unlikely that the U.S. will switch back to a high-real-interest-rate regime in 2017. “The low-real-rate regime is a global phenomenon,” he said, adding that it has been many years in the making and is unlikely to turn around quickly.

Will the new administration’s policies drive the U.S. real GDP growth rate higher?

“Whether the new administration’s policies represent a ‘regime shift’ depends on whether these policies will have a sustained impact on productivity,” Bullard said, adding that potential new policies involving deregulation, infrastructure spending and tax reform could improve productivity in 2018 and 2019. Other policy proposals, such as those related to trade and immigration, have the potential to affect the macroeconomy over the longer term.

Is U.S. inflation about to move higher?

Bullard noted that while inflation has been below the FOMC’s 2 percent target in recent years, due in part to low commodity-price effects, headline inflation is expected to return closer to target in the quarters ahead.

In examining whether there is currently undue inflationary pressure building, he noted that inflation expectations remain low. “Market-based measures of inflation expectations remain somewhat low relative to the mid-2014 benchmark, when they were at satisfactory levels,” he said. “Consequently, it does not appear that undue inflationary pressure is building so far.”

Should the Fed’s policy rate move meaningfully higher in 2017?

Bullard reiterated that any effects from the new administration’s policies are only likely to be observed in 2018 and 2019. In addition, the prerequisites for meaningfully higher inflation do not seem to have materialized so far, and real rates of return on short-term safe assets seem likely to remain low globally in 2017. “These considerations suggest that the policy rate can remain fairly low in 2017,” he said.

Could the Fed’s balance sheet now be allowed to shrink?

Bullard noted that the Fed’s balance sheet has been an important monetary policy tool during the period of near-zero policy rates, and that the FOMC has not set a timetable for ending the current reinvestment policy.

“Now that the policy rate has been increased, the Committee may be in a better position to allow reinvestment to end or to otherwise reduce the size of the balance sheet,” he said. “Adjustments to balance sheet policy might be viewed as a way to normalize Fed policy without putting exclusive emphasis on a higher policy rate path.”

In conclusion, Bullard said the St. Louis Fed’s recommended policy rate depends mostly on the safe real rate of return, and such rates are exceptionally low and are not expected to rise soon. “This, in turn, means that the policy rate should be expected to remain exceptionally low over the forecast horizon,” he said. “The new administration’s policies may have some impact on the low-safe-real-rate regime if they are directed toward improving medium-term U.S. productivity growth.”