On April 2, New York Fed President John Williams said that the monetary policy needs to be moved by the Federal Reserve towards a more neutral approach. However, the way the US economy reacts will guide the pace at which it tightens credit.
In 2019, with rates set near the neutral level “the economic expansion started to slow” and the Fed resorted to rate cuts. William noted, while answering questions at a symposium on whether the Fed required to increase the speed of its return to a neutral policy rate that neither discourages nor encourages spending.
“We need to get closer to neutral but we need to watch the whole way. There is no question that is the direction we are moving. Exactly how quickly we do that depends on the circumstances.”
When compared to the approach that has been pushed by colleagues who feel the Fed should race towards a more neutral stance by using larger than usual half-point rate hikes at upcoming meetings, Williams’ remarks suggest a more cautious approach to expected rate increases.
Currently, traders feel that the central bank will hit the median policymaker estimate of the neutral rate, which is 2.4%, by the end of this year. With expectations of a first hike coming at the Fed’s May 3-4 session. In that context, such a pace would need half-point increases at 2 of the Fed’s remaining six meetings in 2022.
In March, the interest rates were raised by 0.25% by the Fed, the start of what policymakers predict to be “ongoing increases” intended to tame inflation currently running at triple the Fed’s 2% target.
The median policymaker projected quarter-point increases only at each meeting during the last Fed meeting, but since then several commissioners have said that — if needed — they were prepared to move more aggressively.
But, the outcome rests on whether inflation eases, according to Williams. He added:
“We expect inflation to come down but if it does not….we will have to respond. My hope right now is that won’t happen.”
Once it starts to shrink the size of its nearly $9 trillion balance sheet, the Fed will also be using a second tool to tighten credit. That is expected to start as soon as May.
The Fed’s “greatest challenge” currently is high inflation and is potentially being pushed higher by the ongoing pandemic, continued labor and supply shortages in the United States, and the war in Ukraine. Williams analyzed the state of the economy in prepared remarks to a Princeton University symposium.
“Uncertainty about the economic outlook remains extraordinarily high, and risks to the inflation outlook are particularly acute.”
Nevertheless, the combination of balance sheet reduction and rate increases is expected to assist ease inflation to about 4% this year, and “close to our 2 percent longer-run goal in 2024” while keeping the economy on track.
“These actions should enable us to manage the proverbial soft landing in a way that maintains a sustained strong economy and labor market. Both are well-positioned to withstand tighter monetary policy.”