The Case for Gradual but Regular Monetary Policy Normalization The Case for Gradual but Regular Monetary Policy Normalization


Boston Economic Club

Speaking in Boston on Wednesday, Eric Rosengren said recent economic reports have been consistent with "continued steady improvement in the economy." Rosengren, the president of the Federal Reserve Bank of Boston, cited growth in payroll employment and earnings, and the unemployment rate declining to his estimate of full employment.

In Rosengren's view, it was "entirely appropriate" to raise the federal funds rate target in March. And "looking ahead over the course of this year, I believe it is likely to be appropriate for the FOMC to raise rates at a more regular – though still gradual – pace."

"My own view is that an increase at every other FOMC meeting over the course of this year could and should be the committee's default, unless economic data come in inconsistent with forecasts," Rosengren said.

"This would still be a fully data-dependent approach, not a preset path, as it would hinge on the incoming data – but the base case would be four tightenings, reflecting the strength of the economy that I believe justifies more regular normalization of interest rates."

He called this approach fully consistent with a "gradual" path.

Even as the economy approaches the Fed's dual mandate goals, Rosengren said the nominal rate is still low and inflation is approaching 2 percent, resulting in a real rate below zero.

"While it is not unusual to have negative real interest rates when the economy is quite weak, it is unusual to still have negative real interest rates late in a recovery when the economy is close to full employment and nearing the inflation target." He described several reasons why the federal funds rate has remained so low in this cycle.

But he also noted the potential costs of an unemployment rate that is below the sustainable rate. Rosengren showed that 28 states are at least one percentage point below their 20-year average unemployment rate.

"A potentially overheating economy may be reflected in movements in the overall price level, in asset prices, or both," said Rosengren, while referencing various indicators.

And he stressed the core motivation for his cautions: "It is important to avoid creating an over-hot economy that could require a more rapid tightening of monetary policy – which would place at risk the economic improvements seen to date." In that spirit he recommends a "gradual but more regular move to normalization."

Rosengren was speaking to the Boston Economic Club and Boston Fed staff, at the Federal Reserve Bank of Boston.