Will Things Only Get Better For US Economy?

When Jerome Powell presided over his first policy move as chairman of the Federal Reserve, it was against a backdrop of very good economic news: Unemployment is low and falling; inflation is low and stable; financial markets remain buoyant. That is also the bad news.

That’s because there are a lot more ways for the economy to get worse than to get better. Powell faces the tricky task of trying to keep growth going, and his success as the most powerful economic policymaker will depend on his ability to judge the various risks to the current expansion.

Within the announcement that the Fed will raise its interest rate target a quarter of a percentage point to a range of between 1.5 and 1.75 per cent, there are signs that Powell and his colleagues think they can lead the US to even greater prosperity while keeping the inevitable risks created by that growth — inflation and financial bubbles — under control.

If all goes according to plan, this would imply that the US economy in 2019 and 2020 will be the healthiest it has been in half a century. Fed officials project the lowest unemployment rate since 1969, paired with more modest inflation than was experienced that year.

To use a common monetary policy metaphor in which a central banker is the driver of a car that represents the economy, Powell expects to be able to keep going at high speed, even as he taps the brakes harder, and all without the engine overheating. Powell delivered crisp answers in his first news conference, which at about 45 minutes was 15 minutes shorter than the sessions typically held by his Ph.D. economist predecessors Janet Yellen and Ben Bernanke. He said at one point he seeks to take a “middle ground” on policy.

“One risk is we wait too long” on interest rate increases “and have to raise rates quickly and that foreshortens the expansion,” Powell said. “We believe that the middle ground consists of continued gradual increases in the federal funds rate”, which is the short-term rate the Fed targets.

The written materials about the rate increase — which signal the views of Powell and the entire policymaking committee he leads — included new language that “the economic outlook has strengthened in recent months”.

And, consistent with that view, the policymakers’ economic projections represent meaningful upgrades from those officials’ expectations in December. The median Fed official now expects gross domestic product to rise 2.7 per cent this year and 2.4 per cent next year, up from the previous projections of 2.5 per cent and 2.1 per cent.

They now expect the jobless rate to decline to 3.6 per cent from the current 4.1 per cent, and stay there through the end of 2020. Even in the boom of the late 1990s, the jobless rate reached 3.8 per cent for only a single month and never fell below that level.

In the Fed’s projections, this would be accompanied by inflation that rises to — and just temporarily above — the 2 per cent target the central bank has set. The Fed has long asserted that it is just as dissatisfied when inflation comes in below the number as above it. But investors have been sceptical; with the median forecast of 2.1 per cent inflation in 2020, Fed officials have put their projections where their mouths are.

Those economic projections signal that Powell and his colleagues believe they can keep running the economy a little hot with mainly good results. But they seem to believe that a more aggressive shift toward higher interest rates will be needed to keep that benign future intact. This very rosy vision for the economy in 2020 depends, if you take their projections and comments at face value, on the Fed’s stepping up its rate increases.

Just focusing on the median of Fed officials’ forecasts for interest rates can mask the degree of the shift. In December, the “central tendency” of Fed officials’ projections was for an interest rate target of between 2.4 per cent and 3.1 per cent at the end of 2019; that range has now shifted up to 2.8 per cent and 3.4 per cent.

In effect, Powell seems to be rejecting ideas recently put forward by various economic pessimists.

For those who argue that the economy is hurtling toward overheating caused by a tax-cut-induced sugar high, the Fed’s message is that rapid growth is more sustainable than pessimists suggest. For those who argue that rate increases will choke off an expansion that is only now starting to provide broad benefits to Americans, the Fed is signalling confidence that the labour market will keep improving despite faster rate increases.

For worriers about financial bubbles, the Fed is signalling that it believes the risk is low and manageable.

There’s another old metaphor that compares being a central banker to the driver of an automobile: The job that Powell and his fellow policymakers face is like driving a car by looking only in the rear-view mirror.

That is, you can really know only what happened in the past, while making decisions about what will happen in the future. And by the time the data gives you definitive evidence of what is happening, it will probably be too late to act on that knowledge.

He’s barely a month into the job, but we’ll soon find out just how skilled a driver Powell really is.

— New York Times News Service