MNI: Fed's Jefferson Sees Rate Cuts Likely Later This Year

The Federal Reserve will likely begin lowering interest rates later this year but officials must beware of both the risk of excessive easing and of unexpected weakening in the economy, Fed Vice Chair Philip Jefferson said Thursday.

"If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back our policy restraint later this year," Jefferson said in remarks prepared for the Peterson Institute for International Economics. There has been some welcome progress on inflation so far but policymakers must remain nimble and vigilant to fresh shocks, he said.

Fed staff estimate PCE inflation was 2.4% in January, down from 5.5% a year ago, and core PCE prices rose 2.8%, down from 4.9%, he noted. The disappointing CPI report for January "highlights that the disinflation process is likely to be bumpy," he said, but "the slowing in core inflation has been especially pronounced in recent months," and as the labor market continues to cool, he expects core services inflation will continue to moderate.

Disinflation over the past year has been accompanied by a low unemployment rate and low layoffs that suggest a path toward a soft landing, he added.

TWO-SIDED RISKS

The vice chair cited three key risks to the outlook including the "important upside risk" that strong consumer spending could stall inflation progress, he said. Consumers might not want to give up previous levels of consumption either because they're optimistic about the future or "keeping up with the Joneses," he said. (See: MNI INTERVIEW: US Inflation To Linger As Fed Loosens-Warsh)

Employment could also weaken and a widening of the conflict in the Middle East could cause commodity prices to spike and roil global financial markets. In the 2001 and 2007 easing cycles, the jobless rate ramped up quickly shortly after rates began falling and the economy weakened rapidly, Jefferson said.

Policymakers should consider "keeping policy restrictive enough to tamp down a possible resurgence of inflation due to the strength of aggregate demand or easing sooner to avoid an undue increase in unemployment," he said.

"The fact that the unemployment rate and layoffs have remained low in the U.S. economy over the past year amid disinflation suggests that there is a path to restoring price stability without the kind of substantial increase in unemployment that has often accompanied significant tightening cycles."