MNI ANALYSIS:Clarida Could Solidify Fed Leadership As Centrist

--Richard Clarida Nominated To Be Vice Chair, Hearing May 15

--Previously Flagged The Chance Of Inflation Overshooting

--Asserted R-Star Will Remain Low, But Gradually Increase

By Sara Haire

     WASHINGTON (MNI) - The outlook for U.S. monetary policy under the Trump

administration is beginning to take shape with his nomination of economist

Richard Clarida as vice chairman and the appointment of John Williams to the

influential post of president of the New York Fed.

     Clarida's nomination hearing in committee is scheduled for May 15. If

Congress gives Clarida the nod, the most influential positions at the Fed will

have been filled by three sure-handed centrists who appear likely to ensure the

continuity of the gradual approach to reducing recent stimulus.

     Clarida appears to identify with the core of the Federal Open Market

Committee on monetary policy. He has also not shied away from opining on the

potential inflation overshoot, low neutral rate and the Fed's

inflation-targeting framework.

     As managing director and global strategic adviser at Pacific Investment

Management Co. and an economics professor at Columbia University, he would

balance Chair Jay Powell's banking and finance background.

--INFLATION OVERSHOOT

     Late last year, Clarida was prescient in flagging the possibility of an

inflation overshoot as fiscal stimulus revs growth this year. He noted after the

December FOMC meeting that fiscal policy will boost demand and warned that "the

market should probably pay more attention to the fact that perhaps Goldilocks is

a little too relaxed about inflation."

     Inflation perked above 2% in recent hiking cycles, he pointed out, whereas

the FOMC's economic projections in December showed price levels approaching but

never breaching 2% over the medium term. It's the "one thing that is not priced

into markets and into scenarios," he said in a PIMCO video posted on its

website.

     Now that the recent data show that inflation has reached 2%, the key

question is how will policymakers handle inflation above 2%. Officials now

expect core inflation to reach 2.1% by the end of 2019 as the economy moved

further above its potential and resource utilization continued to tighten. 

     At the same time, the FOMC reiterated the "symmetric" nature of its

inflation target in the policy statement, and policymakers hinted in subsequent

public remarks that they would not overreact to inflation slightly above 2%

after a prolonged period of sluggish price pressures.

--LOW R-STAR

     In a 2014 PIMCO publication, Clarida was on the forefront of strategists in

proposing that the real neutral rate of interest, or r-star, was closer to zero

than the 2% previously thought by the Fed prior to the recession and that r-star

will only rise gradually. At the time, the view was "way out of consensus," he

said, with the rest of the market catching up to his view in the months since.

     Confirming Clarida's view, Williams, with Fed Board economist Thomas

Laubach, have found empirical evidence based estimates of r-star remaining

persistently low, reaffirming the risk posed to financial stability in the

long-run.

     If r-star remains low and another downturn in the economy occurs in this

low interest rate environment, the Fed would likely have to once again slash

rates to zero. It would become increasingly difficult to use normal monetary

policy tools effectively, running the risk of broaching negative interest rate

territory, something most policymakers said during the crisis that they wished

to avoid.

     Given that r-star is poised to remain low and Williams and Clarida, among

some others, view it only rising gradually, this could be a case for pressing

ahead with gradual interest rate increases when the economy is doing well.

     Clarida does suggest r-star has the chance to rise if financial conditions

support continued economic growth, spurring inflation growth. In a Bloomberg

interview following the December tax cuts announcement, he explained that given

a stimulated economy, there is a possibility of four rate hikes during 2018,

however he cautioned that inflation would have to run continuously higher than

the Fed's target.

--MNI Washington Bureau; +1 212-800-8517; email: sara.haire@marketnews.com

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