US economy

Fed’s Powell sees few signs of US economy overheating


The Federal Reserve does not see risks of the US economy overheating, chairman Jay Powell said, as he defended the central bank’s gradual approach to lifting interest rates against critics that have included President Donald Trump. 

The Fed has signalled it will lift rates again next month, with a December move also widely expected. But prospects get murkier in 2019 as rates close in on current estimates of neutral rates — broadly defined as the interest rate that keeps the economy on an even keel.

Mr Powell, speaking at the annual Jackson Hole symposium for central bankers, did not directly refer to presidential criticism, instead focusing on the academic and historical justification for his cautious approach to rate rises.

He said the Fed was attempting to navigate between twin risks — moving too quickly and needlessly shortening the economic expansion, and conversely lifting rates too slowly and risking a “destabilising overheating”.

“I see the current path of gradually raising interest rates as the [Fed’s] approach to taking seriously both of these risks,” Mr Powell said. “While inflation has recently moved up near 2 per cent, we have seen no clear sign of an acceleration above 2 per cent, and there does not seem to be an elevated risk of overheating.” 

The chairman’s dovish tone prompted a sell-off in the dollar, as investors expressed relief that recent strong economic data would not deter Mr Powell from his go-slow approach. The dollar index, a measure of the greenback against a basket of other currencies, fell 0.6 per cent on the remarks.

Complicating Mr Powell’s deliberations are the Trump administration’s escalating disputes with the US’s largest trading partners and the turbulence in emerging markets. Mr Trump’s attacks on the Fed for lifting rates have also added to market unease. 

Mr Powell’s address, his first as Fed chairman to the Kansas City Fed’s annual symposium, came just a week after Mr Trump said he was “not thrilled” with the Fed’s monetary tightening. 

The Fed chair gave a broadly positive outlook for the US, saying that “with solid household and business confidence, healthy levels of job creation, rising incomes and fiscal stimulus arriving, there is good reason to expect that this strong performance will continue”. 

But he said the Fed’s task was currently being made tricky by the difficulty in pinpointing variables such as the longer-run rate of unemployment or the neutral rate of interest.

The Fed uses what Mr Powell termed “celestial stars” to guide its policy, namely estimates of the natural rate of unemployment, potential output growth, and the neutral interest rate. Guiding the economy using these stars has become more difficult because estimates of the level of these stars has changed significantly. 

For example, estimates of the natural rate of unemployment have fallen sharply as joblessness has tumbled alongside low inflation, while estimates of the potential growth rate have also slipped.

“The FOMC has been navigating between the shoals of overheating and premature tightening with only a hazy view of what seem to be shifting navigational guides,” Mr Powell said.

In the speech, he looked back to other historical episodes when it was difficult to gauge the level of key variables — notably the 1960s and 1970s when monetary policy mistakes contributed to an inflation blowout, and the 1990s when former Fed chairman Alan Greenspan perceived that the economy’s speed limit was rising because of higher productivity, reducing inflation risks. 

Given the uncertainties the Fed was tackling, Mr Powell argued in favour of caution on rates policy and a “risk-management” approach, praising Mr Greenspan’s 1990s approach of waiting for clear evidence of higher inflation before moving rates higher.

He cited the work of William Brainard, which recommends that “when you are uncertain about the effects of your actions, you should move conservatively”. He added: “In other words, when unsure of the potency of a medicine, start with a somewhat smaller dose.” 

This risk-management approach suggests the Fed chief will be wary of over-tightening as policy gets near neutral levels, preferring instead to watch a broad range of indicators as he scans for signs of overheating. Those indicators, he suggested, included financial market excesses, which have been at the roots of the most recent recessions.

The exception to that cautious approach would be if a major crisis loomed or if inflation expectations were to drift materially up or down. In that case, Mr Powell said, he was confident that the FOMC would “resolutely ‘do whatever it takes’”, in wording that echoed European Central Bank president Mario Draghi’s vows in 2012 to defend the euro. 

Mr Powell added, “if the strong growth in income and jobs continues, further gradual increases in the target range for the federal funds rate will probably be appropriate”. 



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