MNI POLICY: Kansas City Fed's George Looking To Go Neutral

By Sara Haire

     WASHINGTON (MNI) - Policymakers should be more data dependent when

determining the appropriate path of policy in order to reach neutral, Kansas

City Fed Bank President Esther George said Tuesday, but she added that while

there is uncertainty over the appropriate path of policy, in order to reach

neutral policy, it remains necessary to continue raising interest rates

gradually.

     "Recessions can also be caused by policy mistakes," George said on Tuesday

at the Agricultural Symposium. 

     She explained that the Federal Open Market Committee, when attempting to

navigate the tricky waters of setting monetary policy, "will need to monitor

incoming data carefully" so as to not cause a recession one way or the other.

However, her outlook is for the expansion to continue at a "moderate pace."

     She explained that going forward, policymakers will need to "adjust their

forecasts and associated policy paths as necessary based on the flow of incoming

data." She also pointed out that policy tends to lag, so the actions of the FOMC

will need to be forward looking in order to stay ahead of the curve.

--UNCERTAINTIES LOOM LARGE

     While incoming data has generally shown the economy is "firing on all

cylinders" said George, there are "significant" risks to both the upside and

downside.

     The main upside risks George identified were "pro-cyclical U.S. fiscal

policy and globally accommodative monetary policies." Despite these policies

potentially having the "short-run benefit of promoting spending...they also

carry a risk of pushing the economy beyond its productive capacity."

     Additionally, accommodative monetary policies in the U.S. and other

economies "encourage risk-taking and incentivize spending over saving," which

could lead to a run up in inflation or financial imbalances, George said.

     In regard to financial imbalances, she voiced mild concern despite

regulators having judged the financial system to be "stable, with manageable

vulnerabilities." She noted that "corporate bond market and subprime borrowers

appear to be at some risk should interest rates rise sharply" and that "asset

prices remain elevated." 

     She concluded that she is "concerned" that there isn't more being done to

increase capital buffers during a time of "cyclical strength."

     A downside risk identified by George was the "uncertainty around trade

policy." There have been reports from business contacts that suggest some firms

are approaching capital spending with a "wait and see" approach, she said.

     The Kansas City Fed President said she will be monitoring whether this will

"materially slow the economy over the next couple of years or threaten the

sustainability of the expansion."

--RATES HELD DOWN

     There were extraordinary measures taken following the 2008-2009 recession

which included a few rounds of quantitative easing that ballooned the Fed's

balance sheet in the process.

     Despite beginning to normalize the balance sheet, it is remains large and

it is "still likely putting downward pressure on longer-term rates, working at

odds with efforts to achieve policy neutrality," she said.

     She also speculated on the yield curve, but was non-committal in addressing

the severity of what this could mean, saying it is "not clear how concerned we

should be about this possibility" of the yield curve inverting.

     She explained that the Fed's large holdings of treasury securities in their

balance sheet "may be keeping longer-term rates below where they otherwise would

be, and therefore distorting the yield curve."

--MNI Washington Bureau; +1 212-800-8517; email: sara.haire@marketnews.com

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