Fed president James Bullard tells us why he disagrees with his colleagues about the need for more rate hikes

St.
Louis Fed President James Bullard speaks about the U.S. economy
during an interview in New York
Thomson Reuters

WASHINGTON, DC – The Federal Reserve may not need to raise
interest rates much further, if at all, given an economy that
remains wobbly and an inflation rate that has fallen short of the
central bank’s target for five years running, St. Louis Fed
President James Bullard said.

In an interview with Business Insider, Bullard expressed concern
about the prospects for US economic growth after repeated
disappointments in recent years.

Unlike many of his colleagues, who are forecasting several
interest rate increases in 2018 and 2019, Bullard wonders whether
the Fed’s monetary tightening might actually be complete after
just four one-quarter point interest rate hikes.

“Interest rates probably don’t have to change much from where
they are today,” Bullard said. “We’re below target on inflation,
it has surprised down this year, we don’t have to be in any hurry
to raise rates in that environment.” That view puts Bullard
much closer to the implicit forecast in financial markets, which
casts serious doubt on the Fed’s official estimates for as many
as three rate increases per year over the next two years.

The Fed’s preferred inflation measure has slipped this year, and
stood at 1.4% in August.

Andy Kiersz/Business Insider

“Growth has been slower during this recovery than we expected,
certainly than I expected, and the slow growth is a concern,”
added Bullard, who became St. Louis Fed President in 2008, at the
height of the worst financial meltdown in modern history.

“You’re getting so far away now from the crisis that you might
have thought growth would have gotten back to normal by now — I’m
not sure it really has.”

The US economy has struggled to maintain a 2% growth rate in
recent years, although the unemployment rate has fallen sharply
from a 2009 peak of 10% to a historically low 4.4%. However, some
economists believe the job market is far from fully healed,

given a lack of wage growth, widespread underemployment and
the prevalence of part-time and contract work. 

That could explain why US inflation has chronically undershot the
Fed’s 2% target — if the economy is running below its full
potential, companies will find it hard to raise prices because
consumers are struggling. Low inflation sounds like a great thing
on paper, but not when it comes to a person’s paycheck. When
inflation stays too low for too long, it can contribute to a
cycle of economic stagnation as people delay purchases for fear
of job loss or hopes of future price declines.

Another possible factor keeping inflation at bay is the increase
of technology’s share of the economy, Bullard said.

“I am open to ideas of technology being a driving force here,” he
said. “Technology is becoming a more important part of the
economy, a bigger share of the economy, and we know something
about tech prices, they decline over time, they’ve been declining
for decades. I could see that as a disinflationary force.”

Uncertain future at the Fed’s board

Minutes from the Fed’s September meeting released October
11 showed Bullard is not alone in his concern about low inflation
and economic weakness. “
Many participants expressed
concern that the low inflation readings this year
might reflect not only transitory factors, but also the
influence of developments that could prove more persistent,” the
report said.

Clouding the outlook, a number of vacancies on the Fed’s board
mean a number of leadership changes are afoot,
including the likely replacement of Janet Yellen as central bank
chair. The Federal Open Market Committee, which sets monetary
policy, is comprised of seven board members (although it has not
been fully staffed for some time because of political acrimony
over appointments) and 12 district bank presidents. 

Bullard said this layered structure should ensure that the next
Fed chair and additional board governors will not veer too far
from the current policy course — or at least not the way the Fed
reacts to incoming economic data.

“The Fed is a big institution, it’s a sprawling institution, and
you do have a lot of institutional memory among the regional bank
presidents in particular and the governors that are staying and
you have a very competent staff that has a lot of experience,” he
said.

“It’s like a supertanker — you can change direction, but it’s
going to only change direction slowly. For that reason, there’ll
be a lot of continuity in policy no matter who is named. and I
think that’s good for the US economy and the global economy.”

Asked whether he was worried about the Fed’s independence under a
president who has appeared to value “loyalty” in his appointees,
Bullard said he’s not too preoccupied.

“I don’t think [Donald Trump] is going to be able to try to micro
manage,” the Fed, he said. “Usually White Houses have not tried
to do that.”

Shrinking the balance sheet

The Fed announced in September that it would begin shrinking its
$4.4 trillion balance sheet, which expanded sharply during the
recession as the Fed embarked on several rounds of bond
purchases, also known as quantitative easing.

Bullard said it was wise for the Fed to separate balance sheet
policy from interest rates as part of its withdrawal of monetary
stimulus, because it should allow the Fed’s portfolio to shrink
passively, without signaling anything in particular about the
future path of monetary policy itself. That will help prevent any
adverse market reaction, he said.

Andy Kiersz/Business Insider

When the Fed first embarked on its policy of bond buys or
quantitative easing during the recession, Bullard was a big
advocate for selling those securities first before embarking on
interest rate hikes.

Today, he still believes that would have been the preferable
option, but he’s happy the central bank has come around to the
idea that a smaller reserve base will make it easier for the Fed
to focus solely on the tried-and-true policy of raising and
lowering official interest rates. It could not do so during the
crisis because the federal funds rate was already at zero
starting in December 2008, where it remained for exactly seven
years.

Since then, the Fed has raised rates four times to a range of 1%
to 1.25%, and markets see a decent chance of a December rate
increase.

Bullard is not convinced: “The main news this year in the
monetary policy world has been the low inflation in the US, with
surprise to the downside,” he said.

“I can appreciate that people tell me ‘don’t worry it’s going to
recover’ but why not wait and see?” he added. “I wouldn’t make a
policy move betting on that recovery I would just stay where we
are, then if it does come back we’re still below target anyway.”