MNI INTERVIEW: Richmond Fed's Athreya: Restrictive Rates Risky

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve should be wary of setting a course

to deliberately overshoot the neutral level of interest rates, the research

director at the Richmond Fed told MNI, arguing that this approach, recommended

by some other central bank officials, would run the risk of excessive

tightening.

     "A firm commitment to a path that involves deliberate overshooting or rates

above their longer run levels is something that is maybe difficult to achieve in

a very smooth way," Kartik Athreya said in an interview. "From a risk management

perspective, that suggests not necessarily baking in a path that would squarely

and inexorably take you to a stance of what is seen as overshooting."

     Instead, exceptionally low unemployment at a time when the U.S. economy is

running hot calls for a gradual and data-dependent approach to returning

interest rates to a neutral setting, he said.

     Fed officials have argued that several more interest rate increases over

the next couple of years are needed to prolong the current expansion and guard

against any jump in inflation, but there is some difference of opinions over

whether the central bank should take a pause at neutral. Officials including

Boston Fed President Eric Rosengren and Chicago Fed President Charles Evans have

said rates could rise to "mildly restrictive" levels.

     Economists at the Richmond Fed currently estimate the neutral rate at

around 3.25%, about a point above rates at present. And while Athreya warned

against putting too much stock in any precise estimate of the theoretical rate,

he added: "Almost every measure of the natural rate of interest suggests -- at

least at the median -- that we're actually very far away from those numbers."

     --RARIFIED TERRITORY

     America's economy has turned in a performance well beyond what's

sustainable this year as unemployment sank to its lowest since the 1960s.

     Whether one looks at jobless rates across demographic groups, labor force

participation trends or anecdotal feedback from hiring managers, the economy is

in "rarified territory," Athreya said. And based on the still high numbers of

job vacancies, it's reasonable to expect the unemployment rate to fall still

further into early next year.

     The high level of resource utilization is "the prima facie evidence that

perhaps policy is still acting in a way that's accommodative and fostering a

high level of economic activity," Athreya argued.

     It suggests that "continued normalization of policy on the rate front seems

to be exactly the appropriate thing to do."

     --LOW INFLATION

     The Fed's current policy path is calibrated for a scenario in which

inflation remains low and contained. FOMC projections show core PCE reaching

2.1% next year and staying there.

     While a change in the tone of underlying inflation would get Athreya's

attention, the trend would have to be sustained and in concert with a change in

inflation expectations to convince him that price pressures have stepped up, he

said.

     As for the link between low unemployment and rising inflation, Athreya

noted that despite historic tightening in the labor market, low productivity

growth has acted as a headwind on wage growth. Data show "we can have a tight

labor market without ballooning wage inflation," and "productivity is a way to

square that circle."

     That again highlights the Fed's emphasis on the gradual return to more

normal interest rates, he said. The approach also ensures that "we don't create

inflationary pressures that we have to deal with in less pleasant ways."

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

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