CHICAGO – Federal Reserve Bank of St. Louis President James Bullard presented “Remarks on the Current Stance of U.S. Monetary Policy” to the Union League Club of Chicago on Monday.
Bullard reviewed several considerations that suggest a downward adjustment in the Federal Open Market Committee’s policy rate—the federal funds rate target range—may be warranted soon. In particular, he discussed the recent global trade disputes, expected slower growth in 2019, low inflation expectations and the Treasury yield curve’s more decisive move toward inversion.
“The FOMC faces an economy that is expected to grow more slowly going forward, with some risk that the slowdown could be sharper than expected due to ongoing global trade regime uncertainty,” he said. “In addition, both inflation and inflation expectations remain below target, and signals from the Treasury yield curve seem to suggest that the current policy rate setting is inappropriately high.”
Bullard concluded, “A downward policy rate adjustment may be warranted soon to help re-center inflation and inflation expectations at target and also to provide some insurance in case of a sharper-than-expected slowdown.”
Bullard explained that recent developments in global trade negotiations suggest that it may be more difficult to reach a stable global trade regime than previously thought, and that this is likely to chill global investment and feed into slower global growth. “The direct effects of trade restrictions on the U.S. economy are relatively small, but the effects through global financial markets may be larger,” he said.
Bullard noted that U.S. monetary policy cannot reasonably react to the day-to-day give-and-take of trade negotiations. “However, an environment of elevated uncertainty surrounding the global trade regime may be a negative factor for global growth that could feed back to U.S. macroeconomic performance,” he said.
Regarding economic growth, Bullard noted that U.S. real GDP has been growing at a 3.2% pace over the last year, but growth for 2019 as a whole is expected to be slower.
“To the extent global trade uncertainties have become more severe, this slowing may be sharper than previously anticipated,” he said.
Bullard then addressed low inflation expectations. Actual inflation and market-based inflation expectations both remain below the FOMC’s 2% inflation target, he noted.
“This is occurring despite more than two years of upside surprise in the U.S. real economy,” Bullard said. “This is clearly concerning for the credibility of the inflation target.”
Turning to a discussion of the yield curve, Bullard explained that inversion in the past has tended to predict the onset of recession in the U.S. He noted that some portions of the Treasury yield curve are inverted today, and this inversion has become more pronounced in recent trading. In particular, he pointed out that the 10-year yield is below the effective federal funds rate.
“Financial markets appear to expect less growth and less inflation going forward than the FOMC does, a signal that the policy rate setting may be too restrictive for the current environment,” Bullard said.
Bullard then discussed a potential monetary policy response as the FOMC faces a slowing economy with some downside risk due to escalating global trade regime uncertainty, while actual inflation and market-based inflation expectations remain below target.
“A downward adjustment of the policy rate may help re-center inflation and inflation expectations at the 2% target, and simultaneously provide some insurance in case the slowdown is sharper than expected,” Bullard said, adding, “Even if the sharper-than-expected slowdown does not materialize, a rate cut would only mean that inflation and inflation expectations return to target more rapidly.”
Bullard turned to an analogy. He recounted that monetary policy was successfully normalized in the mid-1990s. He noted that the policy rate was increased 300 basis points between early 1994 and early 1995, similar to the 225 basis point normalization that ended in December 2018. He added that the FOMC subsequently lowered rates somewhat.
“The economy did not enter a recession but instead boomed during the second half of the 1990s,” Bullard said. “This example shows that policy rate normalization can be accomplished without damaging the prospects for an extended period of growth.”