MNI POLICY: Rosengren: Fed Hikes Contingent On 3 Conditions

Highly accommodative monetary and fiscal policy are appropriate until a vaccine is widely available and the Federal Reserve is committed to not normalizing interest rates until inflation is above its 2% target unless financial instability risks emerge, Boston Fed President Eric Rosengren said Wednesday.

The federal funds rate range is expected to remain near the currently zero level until three conditions are met, Rosengren said in prepared remarks.

First, that the economy reaches maximum sustainable employment. Second, that inflation has risen to 2%. Third, that inflation is on track to moderately exceed 2% for some time, the Boston Fed chief told the Boston Economic Club.

However, these three conditions "come with a caveat that no risks emerge that could impede the Fed achieving its dual mandate – such as increased financial instability," he said.

"In essence, the Committee is committing to waiting until inflation is above its long-run target before normalizing the federal funds rate, unless other important risks become significant. The lethargy of the inflation rate below the 2 percent target essentially since 2008 has made the FOMC willing to overshoot the 2 percent target before normalizing rates, accepting the added risk to financial stability from holding interest rates near zero for an extended period of time."

LESS OPTIMISTIC

Rosengren said his unemployment forecast is less optimistic than the median forecast in the SEP released last week that showed the unemployment rate dropping to 7.6% by the end of 2020, to 5.5% at the end of 2021, and then dropping down to 4.6% by the end of 2022.

The Fed's median outlook "constitutes a rapid return to full employment, considering the extent of the downturn from the pandemic this spring," said Rosengren, who is not a FOMC voter this year. "While I expect the economy to recover in time, my own expectation is that it will be more gradual than the median forecast of FOMC participants."

The Boston Fed chief's less optimistic outlook hinges on concerns over a second wave of the coronavirus, fiscal support that would probably not be realized until early 2021, expectations that financial spillovers from businesses impacted by the virus will become a more significant headwind going forward, and more difficult job transitions going forward.

"The most likely labor market outcome seems to me to be continued improvement, but with slower gains in employment than we have experienced since April," he said. With such an outlook, Rosengren said additional fiscal stimulus and continued monetary stimulus remain necessary, despite some of the encouraging economic data received over the summer.

"Until a vaccine is widely available, it is appropriate to have highly accommodative monetary and fiscal policy," he said. "Monetary policy is pursuing new and imaginative ways to deal with the effects of this pandemic. However, my view is that additional fiscal policy is probably the more effective tool at this time, since it can directly allocate money to firms and businesses most impacted by COVID-19 without requiring them to take on additional debt that must be repaid."