Top US economists urge later Fed rate hike

28 Feb6:40 AM

[NEW YORK] Raising interest rates too late is safer than acting too early, an influential Federal Reserve official said on Friday, endorsing a high-profile research paper that argues the US economy, given time, can rebound to the strong growth rate to which Americans are accustomed.

The paper by four top US economists, presented on Friday to a roomful of powerful central bankers in New York, argues the Fed would be wise to keep rates at rock bottom for longer than planned and then tighten monetary policy more aggressively.

New York Fed President William Dudley, who offered a critique of the paper, cited currently low inflation and warned against being too anxious to tighten monetary policy.

The risks of hiking rates "a bit early are higher than the risks of lifting off a bit late," he told a forum hosted by the University of Chicago's Booth School of Business. "This argues for a more inertial approach to policy." The US central bank is in the global spotlight as it weighs when to lift rates after more than six years near zero, and how quickly to tighten policy thereafter.

Some policymakers, like Cleveland Fed President Loretta Mester, caution against waiting too long, given concerns about potential financial stability and an erosion of public confidence in the economy.

Fed Vice Chair Stanley Fischer, answering a question at the forum, said without hesitation that the central bank will hike rates this year despite some second-guessing among investors. The first rate hike is "getting closer," he said, adding that the central bank will not follow a pre-determined path of tightening thereafter.

The paper's authors, like Mr Dudley, offer a somewhat dovish solution to the dilemma of when to begin.

They conclude that the Fed cannot be certain to what level it should aim to ultimately raise its key rate. But this equilibrium level, they say, has not fallen as low as claimed by those who warn of a "secular stagnation" in the United States.

Given the uncertainty, "there may be benefits to waiting to raise the nominal rate until we actually see some evidence of labor market pressure and increases in inflation," wrote the economists, including Jan Hatzius of Goldman Sachs and Ethan Harris of Bank of America Merrill Lynch.

They suggest a "later but steeper normalization path" for rate rises than the Fed's own predictions, which imply the first hike around mid-2015 followed by more. Under median forecasts for Fed policymakers, the fed funds rate would hit about 1 per cent by year end and 2.5 per cent a year later.

Fed Chair Janet Yellen said on Wednesday "we don't yet know what the new normal is" in terms of growth.

But the paper offered an optimistic defense of US resilience in the face of a growing chorus of pessimists, including former Treasury Secretary Lawrence Summers, who have argued that persistently weak demand for capital means Americans need to get used to a less muscular economy.

The authors wrote in their 80-page paper that this secular stagnation theory is "unpersuasive," arguing temporary factors like household savings and fiscal tightening made the recovery from recession slower than expected.

REUTERS