MNI POLICY: Fed's Clarida: Gradual Hikes As Rates Near Neutral

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve Vice Chairman Richard Clarida on Tuesday

stressed the importance of raising interest rates gradually as officials

evaluate incoming data and refine their estimates of the neutral rate of

interest and natural rate of unemployment. 

     The Fed's benchmark short-term rate remains below officials' estimate of

its neutral setting, but "it is much closer to the vicinity of r* than it was

when the FOMC started to remove accommodation in December 2015," Clarida told an

investor conference in New York. 

     However, r-star, or the neutral rate, is not only uncertain but evolving as

the economy moves forward, he noted. And the same can be said about the

so-called natural rate of unemployment, or u*. 

     "This process of learning about r* and u* as new data arrive supports the

case for gradual policy normalization, as it will allow the Fed to accumulate

more information from the data about the ultimate destination for the policy

rate and the unemployment rate at a time when inflation is close to our 2

percent objective," Clarida said. 

     --SYMMETRIC RISKS

     The fundamentals of the U.S. economy are robust, and GDP growth in 2018 is

on track to hit a record high in the current expansion, Clarida said. The labor

market "remains healthy" as well, with the jobless rate at a 50-year low. 

     Yet inflation has shown little sign of breaking out of the vicinity of the

2% objective of the Fed, in part due to a slight uptick in productivity growth

and hours worked this year. 

     Against that backdrop, the Fed must balance the risks associated with

raising rates too quickly and not quickly enough, and it should let data be its

guide, Clarida said.  

     "Risks have become more symmetric and less skewed to the downside than when

the current rate cycle began three years ago. Raising rates too quickly could

unnecessarily shorten the economic expansion, while moving too slowly could

result in rising inflation and inflation expectations down the road that could

be costly to reverse, as well as potentially pose financial stability risks." 

     --DATA DEPENDENT

     The Fed needs to let incoming data guide its policy path in two ways,

Clarida said. 

     If incoming data on inflation and inflation expectations are running higher

than projected at present, then "I would be receptive to increasing the policy

rate by more than I currently expect will be necessary," he said. 

     That type of data dependence would be sufficient if "the parameters of the

economy are known," he added. However, the long-run destination of the economy

is unknown and must be continually evaluated as well. 

     "Incoming data can reveal at each FOMC meeting signals that will enable it

to update its estimates of r* and u* in order to obtain its best estimate of

where the economy is heading," Clarida said. 

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

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