LONDON, England – Federal Reserve Bank of St. Louis President James Bullard addressed “The Path Forward for U.S. Monetary Policy in a Global Context” on Thursday during the Official Monetary and Financial Institutions Forum’s City Lecture.
Given that the U.S. economy remains in a low-growth, low-inflation, low-interest-rate regime, the current level of the policy rate (i.e., the federal funds rate target) is appropriate, Bullard noted. “The most likely outcome over the forecast horizon is that the regime persists and, hence, the current level of the policy rate remains appropriate,” he said. “Many future developments could impact this policy path, but the Fed does not need to act pre-emptively with respect to any of them.”
The Low-Growth, Low-Inflation, Low-Interest-Rate Regime
In looking at the low growth rate of U.S. real gross domestic product (GDP), Bullard said data since the financial crisis suggest that the U.S. has converged to 2 percent real GDP growth, while inflation remains low.
He noted that the most recent estimate for real GDP growth in the first quarter is 1.4 percent at an annual rate (according to the Bureau of Economic Analysis). He also observed that tracking estimates for second-quarter real GDP growth suggest some improvement from the first quarter, but not enough to move the U.S. economy away from a regime characterized by 2 percent trend growth. “The 2 percent growth regime appears to remain intact,” he said.
Bullard then discussed the low level of inflation in the U.S. and how the inflation rate has been below the FOMC’s target of 2 percent since 2012. “Recent inflation data have surprised to the downside and call into question the idea that U.S. inflation is reliably returning toward target,” he explained.
Regarding U.S. monetary policy normalization, Bullard noted that while the Fed has been normalizing monetary policy by increasing the policy rate, it has been doing so against a backdrop of relatively weak U.S. real GDP growth, downside U.S. inflation surprises and a global regime of low policy rates. “The financial market reaction has been reflected in a lower U.S. 10-year Treasury yield, lower market-based U.S. inflation expectations and an implied policy rate path closer to the St. Louis Fed path for 2017 and 2018 of 113 basis points,” he said.
Turning to additional developments concerning the U.S. macroeconomic outlook, Bullard first discussed whether the low U.S. unemployment rate may signal a substantial increase in inflation. “The U.S. unemployment rate declined to 4.3 percent in the May reading,” he noted. “Does this mean that U.S. inflation is about to increase substantially? The short answer is no.”
In examining the estimated influence of unemployment on inflation, he said, “Even if the U.S. unemployment rate declines substantially further, current estimates suggest the effects on U.S. inflation are likely to be small.” He noted that low unemployment also coexists with low inflation in many other countries, such as Germany, the U.K. and Japan.
Bullard then discussed the prospect of higher U.S. growth under new fiscal and regulatory policies. “Will the new fiscal and regulatory policies move the U.S. into a higher-growth regime? The Fed can wait and see,” he said, noting that given the economy is not in a recession today, fiscal policies should not be viewed as countercyclical measures, but rather as supply-side improvements. Also, he said, low U.S. productivity growth could be improved considerably through deregulation, infrastructure spending and tax reform.
Turning to global growth, Bullard noted that the International Monetary Fund (IMF) upgraded its world economic outlook for 2017, with key upgrades for Japan, Europe and China. “Nevertheless, these upgrades are too small and too uncertain to have a meaningful impact on U.S. macroeconomic performance,” he said.
Next, he discussed improvements in U.S. financial conditions, noting that standard financial conditions indexes (FCIs) suggest that conditions have improved since the FOMC’s December 2016 meeting. He explained that this type of improvement is sometimes interpreted to mean that the FOMC’s decisions to increase the policy rate are not having any effect. He noted that some of the drivers of FCI movements include low volatility as measured by the VIX, higher equity valuations and lower credit spreads. “The FOMC has not historically targeted these types of variables when making monetary policy,” he noted.
In summary, “The U.S. economy remains in the low-growth, low-inflation, low-interest-rate regime that has characterized recent years,” Bullard said. “U.S. inflation and market-based inflation expectations have surprised to the downside in recent months. Low unemployment readings are probably not an indicator of meaningfully higher inflation over the forecast horizon.”
“The current level of the policy rate is appropriate given current macroeconomic data,” he concluded.