MNI EXCLUSIVE: Fed Economists Cite Still Solid US Outlook

By Jean Yung

     WASHINGTON (MNI) - The slowdown in the U.S. economy is not showing signs of

developing into anything worse, but the Fed's limited capacity to cut interest

rates if faced with a deeper downturn adds to the case for a cautious monetary

policy stance, senior Federal Reserve economists told MNI in recent interviews.

     Should the FOMC drop its policy rate near zero again, it will need to turn

to more unconventional tools to support the economy, something policymakers

would sooner put off if they can keep rates at a level that prolongs the current

expansion instead.

     "Given that rates are so low, and current economic conditions indicate that

they will most likely remain low, the chances of a zero lower bound event are

measurable -- within the next 10 years it's elevated," Philadelphia Fed research

director Michael Dotsey said in an interview last week.

     He added: "I think most people would say that the risks right now are a bit

tilted to the downside."

     Weakening growth in Europe and China, the risk of a prolonged trade

standoff between Washington and Beijing, and a ballooning U.S. budget deficit

that may constrain fiscal policy in the event of another recession all bear

watching as the FOMC hunkers down on its patient stance to start the year, he

said.

     --ECONOMY COOLS

     The cooldown abroad and signs of softening in domestic data could persuade

some Fed officials to revise downward their growth forecasts from December's

estimate of 2.3% for 2019, though Chair Jay Powell last week said the U.S.

outlook remained "favorable."

     Soft retail sales in December and January reinforced expectations that

consumer spending growth may slow, while inventory behavior in the last three

months of 2018 suggests a pullback is due in the first quarter, a drag on

overall growth. The 35-day partial government shutdown also had a wide impact.

     An unusually weak labor market report in February added to the noise. Wage

growth accelerated, a welcome development for policymakers, but firms reported

very little hiring. Still, the three-month moving average rate of payroll growth

remained at a healthy 186,000.

     "I think it's important to recognize that the economy was widely expected

to slow relative to 2018, and now that it seems to be doing that, it's useful

not to think of it as a portent of anything more negative," Richmond Fed

research director Kartik Athreya told MNI last week.

     A growth forecast in the "mid-2s" for the year remains reasonable, he

added.

     The fiscal stimulus and increases in government outlays last year pushed

growth above 4% midyear but, as widely expected, the momentum soon began to

dissipate. GDP grew 2.6% in the last three months of the year and was up 3.1%

from a year earlier.

     The Fed's internal GDP forecasts for the first quarter are currently

registering 1.4%, according to the New York Fed's model, and just 0.4% according

to the Atlanta Fed, but Athreya cautioned that the negative impact of the

government shutdown is transitory and measurement issues have long plagued

estimates of first-quarter GDP.

     "Given that rates have entered the neutral range and given quiescent

inflation, the weakness in some recent data makes it useful to let the dust

settle before moving ahead," Athreya said.

     --ASYMMETRIC RISKS

     Signs of a broader global slowdown underscore a number of longer-term

worries for the Fed.

     Because interest rates around the world have steadily declined over decades

and normal rates today tend to be much closer to zero, the Fed views risks as

asymmetric, meaning officials' ability to battle inflation is greater than their

toolkit to combat disinflation and negative economic shocks.

     Historically, the Fed has lowered rates by 4 to 5 percentage points during

recessions. With the fed funds rate just below 2.5%, there's not much room to

ease policy in the face of even an ordinary downturn.

     "The post-crisis period has seen many economies around the world stuck for

an extended period at the (effective lower bound), with slow growth and

inflation well below target," Powell said in a speech last week."

     "Persistently weak inflation could lead inflation expectations to drift

downward, which would imply still lower interest rates, leaving even less room

for central banks to cut interest rates to support the economy during a

downturn."

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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