Fed's Clarida says interest rates are 'much closer' to neutral 

  • Fed Vice Chairman Richard Clarida says the central bank should take a "gradual" approach to rate hikes that should also be "data dependent."
  • He says the Fed is "much closer" to a neutral rate of interest than it was when it started hiking in December 2015.

Federal Reserve Vice Chairman Richard Clarida expressed a cautious view Tuesday about how the central bank should proceed in raising interest rates.

The Federal Open Market Committee's newest member, in a speech delivered to bankers in New York, emphasized the importance of policymakers being "data dependent" in how they approach future moves.

"A monetary policy strategy must find a way to combine incoming data and a model of the economy with a healthy dose of judgment — and humility! — to formulate, and then communicate, a path for the policy rate most consistent with our policy objectives," he said in prepared remarks.

Assessing the current state of interest rates, Clarida said the FOMC, which sets Fed monetary policy, is "much closer" to a so-called neutral level that is neither stimulative nor restrictive than it was when the rate-hiking cycle began in December 2015.

"How close is a matter of judgment, and there is a range of views on the FOMC," he said.

The question of the neutral rate — referred to in Fed circles as "r*" — is critical as officials consider the path ahead. Fed Chairman Jerome Powell rattled markets in early October when he said the current target range for the benchmark funds rate of 2 percent to 2.25 is "a long way" from neutral.

Clarida said it's important that Fed officials continually update where they think both the neutral fed funds rate and the natural rate of unemployment, or "u*," should be.

"This process of learning about r* and u* as new data arrive supports the case for gradual policy normalization, as it will allow the Fed to accumulate more information from the data about the ultimate destination for the policy rate and the unemployment rate at a time when inflation is close to our 2 percent objective," he said.

A tumultuous period for the market, in which the S&P 500 has come in and out of a 10 percent correction, has left the Fed and the market a considerable distance apart. While the market expects a rate hike at the December FOMC meeting, it currently is pricing in just one more move in 2019. Current Fed projections, meanwhile, call for three hikes next year.

"U.S. monetary policy has for some time and will, I believe, continue to be data dependent in the sense that incoming data reveal at the time of each Federal Open Market Committee meeting where the economy is at the time of each meeting relative to the goals of monetary policy," Clarida said.

His speech did not mention the current volatility. Instead, he gave a mostly glowing view of the economy and said he expects strong growth with moderate inflation to continue.

"U.S. economic fundamentals are robust, as indicated by strong growth in gross domestic product and a job market that has been surprising on the upside for nearly two years," he said.

He did express some caution about inflation that continues to run a bit below the Fed's goal of 2 percent and said policymakers must be careful not to move so aggressively on rates as to harm the recovery or cautiously and risk overheating.

In addition to price stability, the Fed's other mandate is full employment. With an unemployment rate at 3.7 percent, many Fed officials and economists think the economy could be past full employment.

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