Dudley said the Fed is unlikely to follow any particular set guidelines, such as the Taylor Rule, when deciding when and how to hike rates. The rule offers guides about increasing rates according to levels of unemployment and inflation, but Dudley said "monetary policy cannot be put on autopilot guided only by a fixed policy rule."
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"The fact that market participants have set forward rates so low has presumably led to a more accommodative set of financial market conditions, such as the level of bond yields and the equity market's valuation, that are more supportive to economic growth," he said, according tp prepared remarks.
"If such compression in expected forward short-term rates were to persist even after the FOMC begins to raise short-term interest rates, then, all else equal, it would be appropriate to choose a more aggressive path of monetary policy normalization as compared to a scenario in which forward short-term rates rose significantly, pushing bond yields significantly higher," he added.
Dudley said rates have remained where they are in the U.S. partly because of similar action in Europe and Japan.
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On economic issues, he said it's too early to say whether growth is stuck in slow mode over a long period of time—so-called secular stagnation—but he did say gross domestic product growth will remain muted over the medium term.
"I do think that the real potential GDP growth rate will be lower over the medium term, held down by much slower growth of labor input and an anticipated continuation of lackluster productivity growth performance," he said.
Also, he predicted that the long-run funds rate will be 3.5 percent.