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NY Fed's Williams on the outlook for monetary policy: 'It depends'

Brian Cheung
Reporter

New York Fed President John Williams shied away from offering any prediction on the number of rate hikes needed for 2019, reiterating that the Fed should exercise “data dependence and flexibility.”

“I’m not going to say whether we would ever need to raise interest rates or lower interest rates in the future but for the time being I think we’re in a good place,” Williams said.

Speaking at the Economic Club of New York Wednesday, Williams said he believes the economy is currently right at its neutral rate. Williams said his estimate for “r-star,” or the interest rate level where policy is neither stimulative nor restrictive. At a current federal funds rate of 2.4%, Williams says rates are fine where they are right now.

But what would the Fed do if that economic outlook changes?

“My short answer: it depends,” Williams said, pointing to the need for more data on uncertainties abroad. He said geopolitical risks like Brexit and trade negotiations have created “angst” in market participants who have sidelined hiring and investment amid the uncertainty.

Overall, Williams said his estimate for the potential growth rate of U.S. GDP is about 2%, which he attributed to slower labor force and productivity trends.

Balance sheet

On the Fed’s process of shrinking its balance sheet, Williams said he expects the Fed to make further decisions “over coming months.”

Williams echoed the likes of Fed Chair Jerome Powell in saying that they are targeting a balance sheet large enough to match bank appetite for reserves. Powell said estimates of $1 trillion, in addition to a buffer, are a “reasonable starting point and estimate of where we might wind up.”

Kansas City Fed paper released Wednesday suggests that the Fed should consider matching its balance sheet with reserves balances somewhere between $1.1 trillion and $1.5 trillion. The paper argues that the Fed would need to make this decision based on how much control it wants over the federal funds rate. In short, the amount of reserves accommodated by the balance sheet has an impact on how much interest the Fed pays on reserves - which is one of the mechanisms by which the Fed alters the benchmark interest rate.

Williams said $1.5 trillion is “definitely on the high-end of these estimates.” He said policymakers are still in the process of making those decisions as it continues to survey the industry.

“As we continue to reduce the amount of reserves in the banking system we’re also gaining a lot of information on what the demand for reserves is,” Williams said.

Inflation

As the Fed continues to wrangle with “muted” inflationary pressures, Williams noted that inflationary risks “just don’t seem to be out there right now at all.”

He expressed frustration with how some inflation readings have misled policymakers on how close they are to the Fed’s 2% inflation target, adding that acknowledged that inflation readings are “not a perfect measure,” adding that inflation expectations in particular are hard to measure.

Williams likened the inflation conundrum to playing a game of “whack-a-mole.”

For the time being, Williams said “inflationary risks just don't seem to be out there right now at all.”

With the February jobs report due on Friday, Williams told reporters that increasing wage growth would not necessarily change his view on inflationary risks. He said wage inflation does not always move in sync with price inflation, which is the measure that the Fed looks at with regard to its price stability mandate.

“[Wage growth is] part of the mechanism by which inflation picks up but it’s kind of an intermediate marker of where we are,” Williams said.

Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.

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