A speech by Governor Lael Brainard at the Center for Strategic and International Studies, Washington, D.C. on “The U.S. Economic Outlook and Implications for Monetary Policy” suggests that whilst the US economic outlook is patchy, interest rates will rise.
This spring marks the end of the Federal Reserve’s calendar-based forward guidance and the return to full data dependency in the setting of the federal funds rate. So it is notable that just as policymaking is becoming more anchored in meeting-by-meeting assessments of the data, the data are presenting a mixed picture that lends itself to materially different readings.
No doubt, bad weather, port disruptions, and statistical issues are responsible for some of the softness in first-quarter indicators of aggregate spending. Indeed, it may be that the dismal estimate by the Bureau of Economic Analysis of the annualized change in first-quarter gross domestic product (GDP), negative 0.7 percent, is principally an extension of the pattern, seen for several years, of significantly slower measured GDP growth in the first quarter followed by considerably stronger readings during the remainder of the year. In that case, it would be appropriate to minimize the importance of the first-quarter estimate in judging the likely path of the economy over the remainder of the year.
But there may be reasons not to ignore the recent readings entirely. First, the limited data in hand pertaining to the second quarter do not suggest a significant bounceback in aggregate spending, which we would expect if all of the weakness in the first quarter were due to transitory factors. Private-sector forecasts of second-quarter growth are centered around 2-1/2 percent, while the Federal Reserve Bank of Atlanta’s GDPNow forecast, which was quite accurate in its prediction of the first estimate of first-quarter GDP growth, is projecting second-quarter GDP growth of only 0.8 percent.
Second, it would not be the first time this recovery has proceeded in fits and starts. The underlying momentum of the recovery has proven relatively susceptible to successive headwinds, which have kept overall economic growth well below the average pace of previous upturns.
My own reading is that earlier, more optimistic growth projections may have placed too much weight on the boost to spending from lower energy prices and too little weight on the negative implications for aggregate demand of the significant increase in the foreign exchange value of the dollar and large decline in the price of crude oil.
Based on today’s picture of moderate underlying momentum in the domestic economy and the likelihood of continued crosscurrents from abroad, the process of normalizing monetary policy is likely to be gradual. It is also important to remember that the stance of monetary policy will remain highly accommodative even after the federal funds rate moves off the effective lower bound, because the real federal funds rate will initially still be low and because of the elevated size of the Federal Reserve’s balance sheet and the associated downward pressure on long-term rates. Moreover, the FOMC has stated clearly that it will reduce the size of the balance sheet in a gradual and predictable manner starting at an appropriate time after liftoff, which will depend on how economic and financial conditions evolve.
In summary, the string of soft data in the first quarter raises some questions about the contours of the outlook. While it is possible that residual seasonality and temporary factors were responsible, it would be difficult, based on the data available today, to dismiss the possibility of a more significant drag on the economy than anticipated from foreign crosscurrents and the negative effects of the oil price decline, along with a more cautious U.S. consumer. This possibility argues for giving the data some more time to confirm further improvement in the labor market and firming of inflation toward our 2 percent target. But while the case for liftoff may not be immediate, it is coming into clearer view. When that time comes, the policy path will be highly attuned to incoming data and not on a preset course, and it is important to be mindful of the possibility of volatility as markets adjust to a change in the stance of policy. Thus, the FOMC will continue communicating as clearly as possible regarding the outlook and the factors underlying its policy determinations.
