MNI Fed's Kaplan: Should Hike Gradually, Patiently in 2018

--Also Warns Getting Behind Curve Would Increase Likelihood of Recession

--See GDP Growth at 2.5%-2.75% This Year, Jobless Rate Falling to 3.6%

--Tax Package Stimulative in Near-Term; Deleveraging Could Depress Growth

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve Bank of Dallas President Rob Kaplan on

Wednesday advocated that the U.S. central bank tighten policy "gradually and

patiently" this year amid robust growth and a tightening labor market. 

     The recent $1.5 billion tax cut will have a positive near-term impact on

growth, the bulk of which should be felt this year and to a lesser extent in

2019 and 2020, he said in an essay on economic conditions. But he warned that

adding to government deficits could eventually hurt growth when the economy

deleverages. 

     The following are select excerpts from the essay: 

     --On Monetary Policy

     Based on these expectations, I believe the Federal Reserve should be

gradually and patiently raising the federal funds rate during 2018. While my

views on the appropriate path of policy will be impacted by economic conditions

as they unfold during the year, I continue to believe that gradual and patient

removals of accommodation will increase the likelihood of extending the economic

expansion in the U.S. History suggests that if the Fed waits too long to remove

accommodation at this stage in the economic cycle, excesses and imbalances begin

to build, and the Fed ultimately has to play catch- up. In my judgment, getting

behind the curve and then trying to catch up would increase the likelihood of

recession in the U.S.

     --On Tax Package 

     The corporate tax reform elements of recent tax legislation should help to

encourage greater business formation and investment, which should lead to

greater productivity and some increase in the growth potential of the U.S.

economy. However, the debt-financed tax cuts included in the legislation are

likely to temporarily stimulate demand, with effects that will peak in 2018, and

gradually fade in 2019 and 2020. Ultimately, we believe that growth will return

back to trend. Dallas Fed economists believe that the expected near-term boost

to GDP needs to be balanced with the concern that debt to GDP is likely to

materially increase in the years ahead. This projected increase in government

debt to GDP comes at a point in the economic cycle when it would be preferable

to be moderating the rate of debt growth at the government level.

     While leverage can stimulate the economy as it is being added, deleveraging

is likely to be depressing to GDP growth. At a minimum, higher government

leverage will make it less likely that fiscal policy will be a realistically

available tool during the next recession. While addressing this issue involves

difficult political considerations and policy choices, the U.S. may need to more

actively consider policy actions that would moderate the path of projected U.S.

government debt growth.

     --On Current Economic Conditions

     The Dallas Fed expects that U.S. GDP will grow at approximately 2.5 to 2.75

percent in 2018. We believe that consumer spending will be strong, owing to a

healthy jobs market and the multiyear improvement in household balance sheets.

We also expect business investment to be stronger than in 2017, and we believe

that improved global growth could also help support economic growth in the U.S.

     Based on our forecast, we expect U.S. labor market conditions to tighten

this year. We forecast that headline unemployment will decline from 4.1 percent

to approximately 3.6 percent by year end.

     Our economists expect cyclical inflation pressures to build during 2018.

While these pressures will likely be at least partially offset by the impact of

technology-enabled disruption, I believe the headline rate of inflation is

likely to firm during the year, and we are likely to make progress toward

reaching the Fed's 2 percent longer-run inflation target. 

     --On Longer Run Challenges

     Our view is that "potential" GDP growth, the sustainable underlying growth

capability of the U.S. economy, is approximately 1.75 percent. This level of

potential GDP growth is lower than we've historically been accustomed due to

several structural issues. 

     Due to the aging of our population, workforce growth in the U.S. is slowing

and is likely to continue slowing. Unfortunately, our economists believe that

these demographic trends will cause the labor force participation rate to

decline to below 61 percent over the next 10 years.

     Our economists have done extensive research regarding U.S. immigration as

well as the immigration policies of other countries. This research indicates

that it would be appropriate for the U.S. to consider reforms to the current

immigration system to more heavily take into account immigrant skills as well as

other employment-based criteria. 

     Improving math, reading and science capabilities, improving college

readiness and beefing up the availability of skills training for potential

workers will likely be essential to improving our workforce productivity,

reducing the number of discouraged workers and contributing to higher GDP growth

in the U.S.

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

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