NY Fed Dudley: US Econ To Grow At 'Slightly Above-Trend Pace'

--Fed Likely To Continue To Normalize Policy Gradually

--Normalized Bal Sheet Of $2.4-$3.5 Trn Seen In Early 2020s

--Hurricane Harvey Won't 'Fundamentally Alter" Underlying Trajectory of US Econ'

By Vicki Schmelzer

     NEW YORK (MNI) - The U.S. economy is likely to continue to grow at a

"slightly above-trend pace," underpinned by favorable fundamentals, such as "low

unemployment, sturdy job gains, and rising wages," said New York President

William Dudley Thursday. 

     As long as the upbeat economic trend continues, "the Fed will likely

continue to remove monetary policy accommodation gradually," he said in a speech

to the Money Marketeers of New York University at the Downtown Association in

New York City. 

     Nevertheless, "the upward trajectory of the policy rate path should

continue to be shallow, in part because the level of short-term interest rates

consistent with keeping the economy on a sustainable long-run growth path is

likely to be considerably lower than it was in prior business cycles," Dudley

said. 

     As the Fed begins to normalize the balance sheet - this also "should exert

some monetary policy restraint over time," although this should have a "quite

modest" impact, he said. 

     Financial conditions play a key role in monetary policy, he said. 

     "All else equal, an easing of financial conditions may warrant a somewhat

steeper policy rate path; conversely, if financial conditions were to tighten

unduly, then this might necessitate a shallower rate path to temper that

tightening," Dudley said. 

     Regarding Fed balance sheet normalization, New York Fed staff projections

see the central bank's balance sheet, currently at $4.5 trillion, shrinking by

about $1 trillion to $2 trillion, which "compares to an increase of about $3.7

trillion in the wake of the financial crisis," he said. 

     As for how long balance sheet reduction will last, "assuming that this

process begins later this year and continues uninterrupted, the balance sheet

would likely normalize in the early part of the next decade," he said.  

     He reiterated his leaning towards the Fed's use of a "floor-type" system,

"in which the Fed maintains a relatively abundant supply of reserves and the

effective federal funds rate it managed by periodic adjustments to the interest

rate the Fed pays on bank reserves."

     This is in contrast to the "corridor" system, where reserves "are

relatively scarce and the effective federal funds rate is managed by frequently

adjusting the supply of reserves to meet demand at the desired federal funds

rate level." 

     On the inflation front, Dudley outlined some of the potentially "one-off"

factors that have weighed on prices recently, "such as the sharp fall in prices

for cellular phone service" and the "increased ability" of shoppers to compare

prices. 

     "If it turns out that structural changes have played a significant role,"

Dudley would view this "as a positive rather than negative, development" as it

would "imply that the U.S. economy could operate at a higher level of resource

utilization without generating a troublesome rise in inflation."

     On Hurricane Harvey's devastating effect on Texas and other states, the

storm will make it difficult to assess economic data in coming months, he said. 

     However, aside from the Texas economy which was hard hit," Harvey should

not "fundamentally alter the underlying trajectory of the national economy," he

said.

     As for the Fed being being more or less predictable in its actions, Dudley

said, "there are plenty of potential surprises from the economic environment

without the Fed seeking to deliberately generate its own." He saw little benefit

in the Fed "artificially adding 'noise'."

--MNI New York Bureau; tel: +1 212-669-6438; email: vicki.schmelzer@marketnews.com

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