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

Repeats Story Initially Transmitted at 14:45 GMT Aug 11/10:45 EST Aug 11
--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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