MNI Fed's Dudley: Case For Gradual Hikes Remains Strong

--Optimistic Near-Term Outlook on Easy Fin'l Conds, Fiscal Boost

--Tighter Labor Market, Wage Gains Should Push Inflation Higher

--Worried About Risk of Hard Landing If Economy Overheats In Next Few Yrs

By Jean Yung

     WASHINGTON (MNI) - Solid momentum in the U.S. economy more than offsets

inflation that remains somewhat below target coming into 2018 and argues for

continued gradual interest rate increases, Federal Reserve Bank of New York

President Bill Dudley said Thursday. 

     In fact the risk of the economy overheating over the next few years,

forcing the Fed to pump the brakes hard, worries Dudley more than the near-term

outlook, he said.  

     "If circumstances evolve close to what I have outlined today, I will

continue to advocate for gradually removing monetary policy accommodation," he

said. "As I see it, the case for doing so remains strong."

     He expects a tighter labor market to lead to wage gains and faster price

inflation. But even if inflation were to remain somewhat below 2% over the near

future, "that might not be a serious problem, if the economy were to continue to

perform well in other respects," he said. 

     "To me, it would imply that the unemployment rate associated with 'maximum

employment' is lower than current estimates and that we could let the labor

market tighten a bit further," something he said he would call a positive

outcome as it signals more people would be able to find jobs. 

     Accommodative monetary policy and easy financial conditions as well as a

boost from tax cuts passed in December and an improvement in the global economic

outlook are set to drive above-trend growth this year, Dudley said. 

     He raised his real GDP forecast for 2018 by about a half to three-quarters

of a percentage point to a 2.5% to 2.75%. About a third of the upward revision

reflects the firmer momentum of the economy going into 2018 and the rest the

stimulative impact of the tax legislation.

     Investment spending should remain solid and likely get a modest boost from

the lower tax rate and the 100% expensing provision for investment. However,

because most of the tax cuts will benefit the corporate sector and higher income

households and those groups tend to save rather than spend extra income, the

boost to growth will not match the 1% of GDP reduction in federal revenues,

Dudley said. 

     "While the fact that inflation is below the FOMC's 2 percent objective

argues for patience, I think that is more than offset by an outlook of

above-trend growth," he said. 

     However looking further into the future, Dudley said overheating strikes

him as a real risk over the next few years. 

     "Not only do we have an economy that is growing at an above-trend pace --

at a time when the labor market is already quite tight -- but the economy will

be getting an extra boost in 2018 and 2019 from the recently enacted tax

legislation." 

     What's more, financial conditions today are easier than when the Fed

started to remove monetary policy accommodation, he said. 

     "If the labor market tightens much further, it will be harder to slow the

economy to a sustainable pace, avoiding overheating and an eventual economic

downturn," he said. 

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

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