Powell says solid economy supports further rate rises
Fed chief says keeping labour markets too tight could raise inflation expectations
Federal Reserve Chairman Jerome Powell said sturdy U.S. economic growth has built a strong case for continuing to gradually lift interest rates, and he warned against policy complacency now that the central bank has nearly achieved its employment and price stability goals.
“Today, with the economy strong and risks to the outlook balanced, the case for continued gradual increases in the federal-funds rate remains strong and broadly supported among” participants on the Fed’s rate-setting committee, Powell said Wednesday.
The Fed’s rate-setting committee unanimously agreed last week to lift the central bank’s benchmark short-term rate for the second time this year, to a range between1.75 per cent and two per cent, and officials pencilled in two more rate increases this year.
Powell spoke at the European Central Bank’s annual policy conference in Sintra, Portugal.
His prepared remarks highlighted the risks of allowing unemployment to fall too low below the level expected to prevail over the long run. Currently, Fed officials estimate that natural level of employment would put the jobless rate at around 4.5 per cent, above the 3.8 per cent unemployment rate recorded in May.
Powell said he saw few risks of bubbles but flagged how the prior two U.S. economic expansions ended after the eruption of financial imbalances, in the technology sector and the housing market, respectively, rather than overheating from excessive inflation.
“We have often seen confidence become overconfidence and lead to excessive borrowing and risk-taking, leaving the financial system more vulnerable,” he said.
Few questions loom larger for the Fed than how low the U.S. unemployment rate can safely go.
If it falls any further, it will stand at its lowest levels since the late 1960s, when sustained low levels of unemployment were followed by large increases in inflation that proved difficult for the Fed to contain.
Powell’s speech flagged the uncertainty facing the Fed be- cause of a limited sample of episodes resembling the economy’s current situation.
He said the example of the late 1960s wasn’t as useful as policymakers might have hoped because the economy has changed significantly over the last half-century.
“The historical comparison does not shed as much light as we might have hoped,” he said.
Today’s economy has more college-educated workers than in the past, which depresses the natural rate of unemployment because they have lower unemployment rates than others.
Powell also said he was hesitant to draw too many lessons from the low-unemployment episode from the late 1960s be- cause people now expect inflation to remain stable, reflecting in part the Fed’s success in keeping prices stable in recent decades.
In the 1960s and 1970s, if inflation went up one year, consumers expected it to rise by at least as much the following year. Officials believe such expectations can be self-fulfilling as workers demand pay increases and businesses raise prices in anticipation.
Still, Powell warned against turning complacent in assuming that stable inflation expectations would prevent growing pressures should unemployment fall lower. Inflation expectations have been stable “because central banks have kept inflation under control,” Powell said.
“If central banks were instead to try to exploit the nonresponsiveness of inflation to low unemployment and push resource utilization significantly and persistently past sustainable levels, the public might begin to question our commitment to low inflation, and expectations could come under upward pressure,” he added.
Powell said there were no signs of this currently happening in the U.S.
Fed officials largely follow a framework that suggests an inverse relationship between inflation and unemployment, known as the Phillips curve. But this relationship hasn’t been strong over the past 20 years, meaning big swings in unemployment haven’t significantly affected inflation.
While this relationship suggests “the implications for inflation might not be large” if unemployment runs below the estimated natural rate for an extended period, Powell said it was possible a “very tight labour market could lead to large, nonlinear effects,” meaning inflation could still rise more rapidly once unemployment remains at a low enough level for a long enough time.
Another example of Powell’s bullish view: In his opening remarks, he didn’t address any of the reasons other Fed officials have cited recently for a potentially slower pace of rate increases, such as instability abroad or a narrowing in the spread between short- and long-term interest rates in bond markets.