Following a Balanced Approach
In remarks Wednesday, Boston Fed President Eric Rosengren summed up the current “dilemma” for monetary policymakers: inflation remains below target, which might suggest more patience before tightening monetary conditions – but unemployment is below the level most policymakers think will be sustainable, which would suggest less accommodative policy.
Balancing these somewhat conflicting factors involves studying the magnitude of deviations, as well as how long the deviations are expected to persist.
Rosengren’s view is that “a gradual increase in interest rates is the balanced approach to reaching both of the Federal Reserve’s mandates in the next several years.”
He said it is “quite likely that unemployment will fall below 4 percent, which is likely to increase pressures on inflation and asset prices.”
Rosengren’s estimate of the natural rate of unemployment, 4.7 percent, means that the current 4.1 percent unemployment rate is 0.6 percentage points below “what I view as the sustainable rate.”
“In my view, that suggests the need to continue to gradually remove monetary policy accommodation, which is quite consistent with market expectations of another increase in December.”
Exploring the data, Rosengren said that while the so-called “misses” in the mandate are of relatively similar magnitudes currently, most forecasts expect the inflation miss to be temporary, but the unemployment miss to be more persistent.
Rosengren acknowledged the argument that inflation dynamics are changing, but said globalization and technology changes do not seem as compelling explanations for recent inflation misses as temporary factors and a change in the inflation-unemployment relationship described by the Phillips Curve. He sees “a gradual rise toward the 2 percent target in the coming quarters.”
Exploring other labor market indicators beyond the widely reported unemployment rate, Rosengren said the data seem “consistent with labor markets being quite tight” – not characterized by slack that could suggesting unemployment is not actually below its sustainable rate.
Rosengren was speaking at the Economic Policy Forum Fall 2017, hosted by the Department of Economics at Northeastern University.