Fed Would Consider Interest-Rate Cuts if Growth Outlook Darkens
Central bank’s vice chairman, Richard Clarida, says any persistent inflation shortfall would also prompt policy reassessment
Federal Reserve Vice Chairman Richard Clarida said the U.S. economy remains “in a very good place” but indicated the central bank would be prepared to consider interest-rate cuts if economic data revealed a material risk of a sharper slowdown than officials currently expect.
Fed officials have been surprised by weakness in inflation so far this year that has defied forecasts of a sustained return to its 2% goal. Mr. Clarida said officials maintained their make-no-moves policy footing at their April 30–May 1 meeting in part because they expect some of the recent inflation softness to be temporary.
Officials met days before a breakdown in trade talks between the U.S. and China led President Trump to raise tariffs on roughly $200 billion in goods to 25% from 10%, representing a significant escalation in tensions. In recent days, bond investors have increasingly calculated that economic weakness would prompt interest-rate cuts to bolster growth.
Mr. Clarida offered no suggestion that any cuts are imminent and affirmed the Fed’s current policy stance in remarks prepared for delivery Thursday at the Economic Club of New York.
But he added an important caveat: “If the incoming data were to show a persistent shortfall in inflation below our 2% objective, or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook, then these are developments that the committee would take into account in assessing the appropriate stance for monetary policy.”
Mr. Clarida said the Fed is as close to meetings its twin goals of boosting employment while maintaining stable inflation as it has been in 20 years. Policy needed to be “nimble” to sustain recent progress, he said.
The central bank’s No. 2 official also said the economy’s performance over the past year suggested the economy may have greater capacity to grow without pushing inflation to undesirable levels than Fed models had previously anticipated.
“While predicting the future is difficult, with available data it appears that in 2018 and in the first quarter of 2019, the supply side of the economy—employment, participation, and productivity—expanded faster than most forecasters outside and inside the Fed expected,” he said.
He didn’t elaborate on the policy implications of any such rethinking, though at a minimum it would suggest even less need for the central bank to raise interest rates. The Fed raised interest rates four times last year to a range between 2.25% and 2.5% in an effort to keep inflation running close to its 2% target.
Since they last raised interest rates in December, some Fed officials have grown uneasy in recent months about their difficulty in generating enough price pressures to keep inflation at their target. In March, inflation excluding volatile food and energy categories rose 1.6% from a year ago, according to the Fed’s preferred gauge, down from 1.8% in January and 2% in December.
At issue is a framework that has long animated thinking in mainstream economics and inside the Fed. It holds that inflation rises as slack across the economy declines, and that the disappearance of slack can best be measured as unemployment declines below a level estimated to be consistent with stable prices.
While the relationship between declining unemployment and rising wages has held up in recent years, the relationship between declining unemployment and rising prices has been very weak.
Fed officials have revised down their estimates of the lowest unemployment rate consistent with stable prices, from 4.7% two years ago to 4.3% in March. Mr. Clarida said Thursday that the range of plausible estimates “may extend to 4% or even below.” The unemployment rate stood at 3.6% in April, a half-century low.
Meanwhile, the workforce participation rate of individuals in their prime working years, between 25 and 54 years old, has risen in recent years, suggesting further scope to boost employment without yielding unwanted inflation. Because prime-age labor-force participation rates remain below prior cyclical peaks, those gains could “have some more room to run,” said Mr. Clarida.
If that is the case, the economy’s capacity to expand without generating more inflation “could be higher than many estimates suggest,” he said.
As he has done since taking office last September, Mr. Clarida urged humility in using macroeconomic models to guide policy making. Economic discipline requires understanding how and whether fluctuations in supply and demand have changed relative to historical experience “and the predictions of our models,” Mr. Clarida said Thursday.