MNI: Higher Productivity, Deficits Boost Rates - Fed's Schmid
MNI (WASHINGTON) - Faster productivity growth and expanding federal deficits boost interest rates over time, while an aging U.S. population exerts a downward force on borrowing costs, creating uncertainty over where the Federal Reserve should set rates over the longer term, Kansas City Fed President Jeff Schmid said Tuesday.
The FOMC has lowered its benchmark fed funds rate 75 bps from its post-Covid peak this year as it's grown confident that inflation is on a path back to 2%, he noted, but officials are uncertain where rates will settle in the long run.
"While now is the time to begin dialing back the restrictiveness of monetary policy, it remains to be seen how much further interest rates will decline or where they might eventually settle," Schmid said in remarks prepared for the Omaha Chamber of Commerce in Omaha, Neb.
A more productive economy allows for both strong growth and moderate inflation, he said. The U.S. has experienced a significant rise in labor productivity growth over the past 18 months as workers settled into better matching jobs after the tumult of the pandemic, Schmid said. That boost could prove more permanent if the massive investments in AI result in productivity leaps, he said.
MORE DEBT
A jump in the supply of government debt is also likely to lead to higher interest rates as the Fed seeks to maintain low and stable inflation, Schmid said. He made no direct reference to the incoming Trump administration, which has promised a slew of policies expected to further widen the deficit.
"Political authorities could very well prefer that deficits not lead to higher interest rates, but history has shown that following through on this impulse has often resulted in higher inflation," Schmid said. (See: MNI INTERVIEW: Fed Cuts To Continue But Neutral Not Far-Tracy)
Demographic trends in the U.S. and abroad, however, are working in the opposite direction, reducing demand for physical capital and investment and depressing interest rates, he noted.
"All three factors are likely to be in effect, and the outcome for interest rates and the economy will be determined by the balance between them," he said. "As an optimist, my hope is that productivity growth can outrun both demographics and debt."