REPEAT:MNI Exclusive: StL Fed Econsts See Dot Plot Moving Down

--Repeating Story Initially Sent 15:44 EDT 08/10

--Don't See Signs of Regime Shift Which Would Necessitate Higher Rates

--'Not Realistic' Monetary Policy Has Much Impact on 10ths PP of Inflation

By Karen Mracek

     ST. LOUIS (MNI) - Economists at the St. Louis Federal Reserve Bank don't

expect another rate hike is needed -- at least not without more evidence of a

regime shift -- and they also expect forecasts from other Federal Open Market

Committee officials will have to move down to where their forecast is later this

year.

     "I think if inflation data comes in like it has for the rest of the year,

you're going to see more ticking down -- pretty much everyone is going to be on

top of us pretty soon," Chris Waller, executive vice president and the director

of research at the Federal Reserve Bank of St. Louis, told MNI exclusively last

week.

     The St. Louis Fed's forecast is for no more rate hikes this year or in the

next two. While there are three other FOMC members who agree with no more rate

hikes this year, according to the June Summary of Economic Projections, the St.

Louis Fed is alone in their projections for 2018 and 2019.

     That's because the regional Fed bank led by President James Bullard last

year took a hard look at why Fed projections have been so wrong and came up with

a new theory that the economy has already landed in a steady state characterized

by low rates, low inflation and low growth.

     "GDP growth is pretty much at trend, unemployment is close to the natural

rate, inflation is actually below target, why are we raising rates?" Waller

asked. "I'm happy to go along with it, just somebody please give me a reason."

     In fact, the economists, who sat down for a lunch with MNI Aug. 1 in their

St. Louis headquarters, don't expect to significantly change their forecast for

rate hikes until there is evidence of a regime shift from this low growth, low

inflation, low interest rate environment.

     "For the foreseeable future, the best guess is that things are just going

to continue," David Andolfatto, vice president in research, told MNI.

     And, he continued, "if one had adopted that view the past eight years or 10

years, that would've served you pretty well relative to the conventional notion

that reverting back to some mean which has resulted in a series of embarrassing

forecast errors."

     The FOMC has been overly optimistic in its forecasts for both inflation and

for expected rate hikes to accompany the return to its 2% inflation target. It

has had to downgrade significantly both forecasts in each of the past five

years. 

     Even this year, early weaker inflation readings pushed policymakers to

scale back their forecast for headline PCE inflation to median expectation of

1.6% in June, down from 1.9% in the March SEP. Still, the median forecast of

policymakers is for this inflation measure to reach 2% next year.

     David Wheelock, vice president and deputy director of research at the St.

Louis Fed, points out, though, a focus on a couple tenths of a percent is

misplaced. "You could make the argument that we're a little bit too focused on

tenths of points when it comes to measuring inflation, or the difference between

the Fed's 2% target and where we actually are," he said.

     "The extent to which monetary policy could make a difference on moves

within a tenth of a point on inflation measures is probably not realistic,"

Wheelock said.

     Instead the focus should be on trying to determine if or when the economy

is seeing a shift in regimes, which could come in the form of higher real rates

of return on short-term government debt or a change in the business cycle.

     Productivity is another regime shifting factor. "What I find is

interesting," Andolfatto said, was "the productivity slow down occurs in about

2005-2006, a couple of years before the crash."

     This, he said, is consistent with a lot of theories "where breaks in

productivity growth manifests themselves in bad ways in terms of asset prices

and stuff like that." It's "an interesting phenomenon to look at," he said.

     Overall though regime shifts are hard to recognize in real time and where

Fed gets into trouble with policy mistakes. "It's very difficult to forecast a

regime change," said Cletus Coughlin, senior vice president and chief of staff.

     "Unfortunately, it takes an accumulation of data to get confidence about

what regimes you're in," added Wheelock.

     Regime changes "happen very quickly," Waller agreed. "But you don't know if

it's a temporary thing. You don't know if it's a permanent thing. That's the

inference problem."

     This is the current issue with inflation. "When you see it suddenly drop:

Is it just because it's a bad quarter?" he asks. "Is inflation just temporarily

low at 2% or is there something that's driving it permanently to 2%?"

     As they look for more evidence of a regime change, the St. Louis economists

are also taking on board a decline in real interest rates, a secular trend,

which have been falling for 35 years.

     "That's affecting what we think is the long or neutral rate, so that's why

we're in no hurry to push up rates," Waller said. "The economy seems to be doing

what it's supposed to be. Real rates have stayed low. We see no reason suddenly

after a 30-year decline it's going to suddenly bounce back."

     Still the economists see their regime framework as mostly optimistic.

"Given our position, anything that can happen is most likely going to push these

things up, not down," Waller said.

     "So that's why all these things are the risk to the upside, so hedging a

bit is actually optimal," he said of the rate hikes so far this year.

     St. Louis Federal Reserve Bank President James Bullard told MNI exclusively

he supported the two 25 basis point rate hikes in March and June, but wouldn't

be supporting anymore, in part because of the weak inflation data.

     Wheelock explained Bullard "has gone along with or agreed with the rate

increases that has occurred partly because we don't know" when a regime change

will occur, and "there's some reason to take out some insurance."

     But, he added, "we don't need to go crazy with four rate increases every

year."

     Bullard, who will vote on the FOMC again in 2019, told MNI Aug. 1 he "would

not support further moves in the near term. ... I think for now we should remain

on pause." Furthermore, he called the median forecast of the FOMC, which calls

for another rate hike this year and three next year, "unnecessarily aggressive."

--MNI Washington Bureau;tel: +1 202 371-2121; email: karen.mracek@marketnews.com

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