When Lael Brainard signals that rate hikes are appropriate or that a balance sheet wind-down is nearing, it’s almost certain that the rest of the committee has already come round to that view as well.
Her views appear to exist near the boundary between FOMC majority-opinion and the committee’s dovish flank, though at a given time it’s not always clear on which side they’ll be. Her speech last September argued that a “new normal” of lower interest rates had likely begun, citing among other factors a flatter Phillips Curve and the effects of activity abroad transmitted through global economic and financial channels back to the US. Yet she also voted in favour of both the December 2016 and March 2017 rate hikes.
And in a speech in mid-January of this year, three days before Donald Trump’s inauguration, Brainard was cautiously optimistic about growth and inflation for a few reasons: the possibility of stimulative fiscal policy under the new administration, continued progress in the labour market, the acceleration of wage growth, and price inflation was continuing to move towards the Fed’s 2 per cent target.
An excerpt:
Moreover, wage growth appears to be picking up gradually in a further sign that slack continues to be taken up. While the employment cost index was up only 2.3 percent over the 12 months ending in September, still well below pre-crisis norms, average hourly earnings have accelerated more noticeably, increasing by 2.9 percent on a 12-month basis in December. Even so, some slack may remain: Relative to pre-crisis levels, the prime-age employment-to-population ratio remains low and the share of employees working part time for economic reasons remains elevated.
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Following a long period of stubbornly below-target inflation, I have been encouraged by recent signs of gradual progress toward our inflation target, as the effects of earlier dollar appreciation and oil price declines appear to be waning. Over the 12-month period ending in November, core personal consumption expenditures prices increased 1.6 percent. This rate is still noticeably below 2 percent, but it is up 1/4 percentage point from a year earlier.
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Given the recent improvement in unemployment and inflation and the possibility of increased fiscal stimulus, risks in the domestic economy are closer to being balanced than they have been for some time. While great uncertainty regarding the path of fiscal policy and its economic effects will remain for some time, with the economy getting closer to full employment, the prospect of a material increase in fiscal stimulus over a sustained period could reasonably be expected to shift somewhat greater probability toward stronger inflation outcomes.
Of those four variables, only the labour market has continued to perform well, while both wage and price inflation have stalled and the prospects for a big fiscal impulse under Trump have been buried under the avalanche of endless political scandal.
Contrast the tone and substance of that January speech with those of the speech she gave today, which starts by rehashing signs of optimism but comes to focus on the contradictory signals from inflation indicators and the labour market:
In the April report, the core measure–that is, excluding food and energy prices–had increased only 1.5 percent on a 12-month change basis. That reading marks a considerable shortfall from the Committee’s 2 percent objective. And there does not seem to have been any progress over the past year or so: Core PCE inflation is about the same over the past 12 months as over the preceding period. Although the past two monthly readings of core inflation have been held down in part by idiosyncratic factors, including upgrades to cell-phone plans, the apparent lack of progress in moving core inflation back to 2 percent is a source of concern.
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Traditionally, economists assessed that as labor market slack diminished and the economy approached full employment, upward pressure on inflation would result, in the statistical relationship known as the Phillips curve. But I am not confident we can count on the Phillips curve to restore inflation to target in today’s economy. Since 2012, inflation has tended to change relatively little–both absolutely and relative to earlier decades–as the unemployment rate has fallen considerably. At a time when the unemployment rate has fallen from 8.2 percent to 4.4 percent, core inflation has undershot our 2 percent target for 58 straight months.
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Attaining the Committee’s symmetric target for inflation on a sustainable basis is especially important in the current environment, with the neutral real interest rate at historically lower levels, in order to ensure conventional policy has room to respond to unexpected adverse developments. Underlying fundamentals, such as import prices and diminishing slack, should lead inflation to resume moving closer to its goal. Nonetheless, currently I see more signs that progress on inflation is slowing than of a breakout of inflation to the upside, as might be the case with a nonlinearity in the relationship between inflation and unemployment when unemployment is very low.
Instead, residual optimism comes from continually loose financial conditions and bettering conditions abroad:
Recent changes in financial conditions have, overall, been supportive of further gains in the real economy. The S&P 500 index is up almost 8 percent since the start of the year. At the same time, a broad measure of the exchange value of the dollar is down about 4 percent so far this year, which should help boost net exports. After moving up sharply late last year, long-term interest rates have moved down somewhat so far this year.
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In addition, the balance of risks has shifted over the past two quarters, with a number of downside risks receding and some upside risks emerging. In particular, the latest international economic data have suggested waning downside risks from abroad, while continued labor market strength and the prospect for fiscal stimulus in the United States present a possible upside risk to domestic demand.
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Importantly, we are seeing synchronized global growth for the first time in many years. Growth forecasts for both advanced and emerging market economies are being marked up, breaking a pattern of repeated downward revisions from 2013 to 2016.
Brainard’s speeches as an indicator of more-hawkish policy ahead only really work in that one direction. That is, a more-hawkish Brainard can help confirm a hawkish shift on the FOMC, but a less-hawkish Brainard might not signal much of anything for the rest of the committee.
In other words, her speech today has few implications for the Fed’s presumed plans to hike rates in June, but still we thought it worth noting in case the wage and inflation data continue disappointing.
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