The suite of communications following today’s FOMC meeting portray a Committee that is much less certain of its ability to follow through on a steady dose of rate increases in the years ahead without jeopardizing the outlook for growth and inflation. Despite a policy statement that contained only minor tweaks, members shifted their interest rate projections lower en masse, and in some cases notably. By year-end 2016, for example, six Committee participants now view only one policy rate increase as appropriate, compared to one participant at the March meeting, and the median policy rate projected for end-2018 is lower by a full sixty basis points.
One reason for the shift lower in the projected policy rate path is the continued uncertainty about the level of the equilibrium policy rate, currently and in the longer run. Indeed, this was a subject that featured quite prominently in the press briefing, and Yellen went so far as to note that the factors currently suppressing the equilibrium rate, such as global headwinds, subdued household formation and anemic productivity growth, may not fade any time soon. As I noted earlier this week, expectations for the equilibrium rate to rise in the future had been an important rationale for beginning to raise rates well before inflation reached the two percent objective. To the extent there is much greater uncertainty about the trajectory for the equilibrium rate, an important foundation for continued policy normalization has been weakened. The Committee may still believe that rates need to rise if inflation continues to inch towards two percent, but the amount of policy firming needed to hit a neutral policy stance is now much less than previously anticipated. Indeed, Committee participants’ median projection for the longer-run equilibrium rate came down by an additional 25 basis points, and has now fallen by a remarkable 75 basis points over the past year. This is a substantial decline and indicates a fundamental shift in the Committee’s thinking about the real equilibrium rate, which I would summarize as follows: its current level remains quite low and likely close to zero; it is unlikely to rise any time soon; and in the longer run it may only be about 100 basis points higher than it is now.
Chair Yellen’s press briefing made clear that the hurdle to a rate increase at the next meeting is quite high. At a number of points in her Q&A, the Chair noted that the Committee will need to reassure itself that underlying momentum in the economy has not diminished, particularly given signs of a slowing in the pace of labor market activity. And when asked specifically about the appropriateness of raising rates in the coming months, the Chair commented that while a July rate increase is “not impossible”, the “Committee needs to make sure there is sufficient momentum” in the economy. This sense of caution given mixed economic signals, in combination with limited policy options at the lower bound and the Committee’s continued realization of a very low equilibrium rate, all lead me to retain my call for a September rate increase while pushing out any rate increases thereafter that until 2017.