Trends and Transitory Shocks Trends and Transitory Shocks

September 27, 2017

Speaking in New York, Boston Fed President Eric Rosengren said that underlying trends suggest "an economy that risks pushing past what is sustainable, raising the probability of higher asset prices, or inflation well above the Federal Reserve's 2 percent target."

"Steps lowering the probability of such an outcome seem advisable – in other words, seem like insurance worth taking out at this time," he said. "As a result, it is my view that regular and gradual removal of monetary accommodation seems appropriate."

Noting that the weakness in inflation readings appears to be transitory, Rosengren said "the declines in the unemployment rate below the level most see as sustainable seem likely to be more long-lasting."

"Discerning the underlying trends in unemployment and inflation – looking through transitory effects – is likely to be quite difficult in coming months," Rosengren said, citing the impact of recent hurricanes on economic data.

In addition, Rosengren noted that the Federal Reserve's dual mandate indicators – employment and inflation – are sending somewhat conflicting signals of late: labor markets have continued to improve, yet inflation has slipped down a notch this year.

Asking how policymakers might resolve the conflicting signals when "the central bank's dual mandate is 'dueling,'" Rosengren explored the forecasts of both central bankers and private forecasters. Both suggest that by the end of next year, inflation is expected to be close to target, while the unemployment rate will continue to fall – and as a result, will move further below most estimates of a sustainable unemployment rate.

"This outcome poses risks – specifically that an overheated economy will lead to price or asset-price inflation, risking the sustainability of the recovery," Rosengren said.

Rosengren noted that low inflation readings are viewed as transitory by both FOMC participants and private-sector forecasters. In contrast, Rosengren noted that most forecasters see the recent low readings for unemployment as persistent, and they envision additional declines on average.

"While such forecasts are still of course subject to errors – possibly even significant ones – I believe policymakers should not overreact to low current inflation readings that are widely expected to be temporary," he said.

"In my view, appropriate risk mitigation would argue for continued gradual removal of monetary accommodation, even though we are currently below the inflation target."

Rosengren was speaking to the Money Marketeers of New York University.

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