John C. Williams, Federal Reserve BRICE WALLACEThe Enterprise
The U.S. economy is doing well and an early start to raising interest rates “would allow us to engineer a smoother, more gradual process of policy normalization,” the top official at the Federal Reserve Bank in San Francisco said recently in Salt Lake City.
John C. Williams, president and chief executive officer, told a group of community leaders that a slowing of the U.S. economy is needed and that the “next appropriate step” is for the Fed to raise interest rates beginning this year.
“I do want to see further improvement in the U.S. economy. We still have a little ways to go until we’re really at full strength, but it is desirable and expected that we’ve actually seen the pace of growth slow over recent months. And I expect that to continue. That is just part of the process of getting to full strength,” Williams said.
“Overall, I do see the economy being on very solid footing. I think we’re on a very good trajectory, despite the global headwinds. There are risks to the outlook, as always. … There are those risks out there, but things are looking up, and assuming we stay on track, this is the year, I think, we should start the process of monetary policy normalization.”
The Federal Open Market Committee, of which Williams is a voting member, recently held off on raising interest rates, in part because the economy is strengthening and nearing full employment, despite global developments presenting downside risks.
“We’re entering now into the seventh year of the economic expansion from the recession, and we’re entering the seventh year with a lot of very solid momentum,” he said, noting that the past five years haveseen GDP growth averaging a little above 2 percent and the unemployment rate falling by nearly a percentage point per year.
“Given the data we’ve seen now and the momentum we have, I expect that this pace of improvement will continue, despite that there are some significant global headwinds,” Williams said.
The momentum is seen in consumer spending, which has increased more than 3 percent over last year, and auto sales being on pace to reach 17 million vehicles this year — “a significant rebound in auto sales,” he said. The ratio of wealth to income is near all-time highs, household debt has fallen and real income growth remains strong, he said.
“Another positive sign is that business spending is on the upswing. So both the consumers and the business side of the economy contribute solidly to growth,” Williams said, predicting that real GDP will grow at a 2 1/4 percent annual rate the second half of this year and be a little over 2 percent in 2016.
On the labor front, about 2.5 million jobs will be added to the economy this year and job vacancies are the highest since data began to be collected in 2000. Williams expects the national unemployment rate — now at 5.1 percent — to drop below 5 percent this year and remain there through 2016.
Still, inflation is “still running below the levels I’d like to see,” Williams said, with the underlying rate stable at just over 1 1/2 percent. That’s happening despite an economy nearing full employment because of the rise of the dollar and the fall in oil prices over the past year, which have lowered import prices and pushed inflation down. But those will dissipate, and with the strong economy, inflation likely will move back over the Fed’s goal of 2 percent in the next two years, he said.
While arguments exist for patience in raising interest rates — including that inflation’s bounce-back could take longer than expected — an earlier start to raising rates would allow interest rates to move to normal levels smoothly and “and, if economic conditions change, with a more smooth, gradual path, we’ll have a little bit more room to maneuver. If instead we wait too long, we’ll have to have broad rate hikes and that takes away some of that ability to adjust policy the way you’d like to,” Williams said.
Waiting also could bring risk of roiling financial markets and slowing the economy in unintended ways, he added.
Williams said he is starting to see signs of imbalances that, if left to grow, could leave the Fed with limited options to deal with them. In the mid-2000s, he said, the housing boom occurred when it was already too late to avoid bad outcomes. Earlier action could have stopped the fallout when the problems were still manageable, he said. House-price-to-rent ratios currently at 2003 levels and rapidly rising house prices represent concerns “if we allow this economy to run too hot for too long.”
People should remind themselves that “we’re in a very different place in our economy today than we were when the Fed instituted the economic policies that got us to where we are today,” he said. In late 2009, unemployment was 10 percent, and 12 million jobs have been added since then, partly because of economy policy.
Williams said he has usually found the argument for patience to outweigh those of raising rates. But as the economy has closed in on full employment, the arguments on the other side of the ledger — for the need to start raising rates — have been “coming into closer balance.”
With current employment trends and inflation expectations, “it does make sense to me to start removing the monetary accommodation that we put into place that helped us get to where we are today.” The first step was removing the third round of “quantitative easing” a couple of years ago.
“But, given my forecast for the economy, I do see it as the next appropriate step that we start raising interest rates by sometime later this year,” he said, adding that that view could change based on economic conditions.
Williams said a “new normal” expectation for the economy is needed. When unemployment was at 10 percent, rapid job growth and unemployment rate lowering were needed. With the economy at full strength next year, 100,000 new jobs each month will be the level needed for stable growth.
“Now, as we’ve gotten closer to full employment, where the economy is getting closer to being a healthy economy,” he said, “it’s actually expected and desirable that we see the pace of growth slow somewhat. … We don’t need to see a full percentage point decline in unemployment every year.”
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