The U.S. tax legislation approved last year is likely to boost growth and investment and is already pushing up equity prices, but should not force the Federal Reserve to raise interest rates any faster than expected, St. Louis Fed President James Bullard said on Thursday.
"A lot of good things were done in this tax bill," said Bullard, who endorsed the alignment of U.S. corporate taxes closer to developed world norms and said he felt that raising the standard deduction would weaken the constituencies behind itemized tax breaks that can distort economic decisions. "I do hold out the possibility that the tax bill will unleash a lot of investment in the U.S. and you will then get an outsized effect."
Bullard said his "base case" was for only a modest increase in capital spending, and a possible shift in the economy's long-term potential growth by a few tenths of a percentage point — not a dramatic change for the near term but important over the long run.
The recent surge in stock market prices, he said, was a logical "revaluation" of the corporate sector in light of the lower corporate tax rate, not a sign that investors have become irrationally confident or that a risky financial bubble is developing.
For now, he said, the Fed has no reason to think the tax legislation will lead to excessive inflation or other problems that would require a faster pace of rate increases. Indeed he said he is sticking with his current view that rates should be held steady until it is clear the economy has shifted to a faster underlying pace of growth, productivity has increased, or inflation and global interest rates move higher.
The bigger concern, he said, is if the Fed continues raising its short-term target interest rate and long-term yields remain low, raising the possibility that the overall yield curve becomes downward sloping with short-term rates higher than long-term ones. That sort of "inversion," a sign that investors do not trust the long-term outlook and will not place long-term bets, has been a harbinger of a recession that the Fed should not risk.
"The time to have that debate is now, in the first part of 2018," Bullard said.