Fed Lockhart: A Kaleidoscopic Context For Monetary Policy

Dennis Lockhart
President and Chief Executive Officer
Federal Reserve Bank of Atlanta

Rotary Club of Savannah
Hilton Savannah DeSoto
Savannah, Georgia
March 21, 2016

Last week, the Federal Open Market Committee, the Federal Reserve’s group responsible for setting monetary policy, met and decided to keep unchanged the benchmark policy interest rate that influences the rates that businesses and households pay and earn.

The statement issued at the conclusion of the meeting characterized an economy that continues to grow at a moderate pace supported to a significant extent by growth of consumer spending.

The statement noted that progress continues on both monetary policy objectives—employment and inflation. Job gains continue to accumulate quite satisfactorily, and some inflation indicators show movement higher in the direction of a healthier rate of inflation.

Despite continuing economic progress, the Committee cited recent global economic and financial developments as a reason for its decision.

I supported the Committee’s decision. Although I believe further normalization of interest rates will likely be justified by economic performance this year—and possibly relatively soon—I felt a patient approach made sense at this meeting.

Today I will elaborate on the factors I considered most important in the recent policy decision. Looking ahead, I’ll lay out my near-term economic outlook, and I’ll comment on how the context of risks and uncertainties around the outlook can affect decision making on policy.

I will be sharing my personal views, as always. I’m not speaking for the Federal Reserve or the Federal Open Market Committee.

I’ll start with my current assessment of economic momentum. I see the economy on a growth track that should produce moderate growth this year—between 2 percent and 2 1/2 percent.

This outcome could be in question if you simply extrapolate from growth in the fourth quarter of 2015. The fourth quarter was relatively weak—currently estimated at 1 percent. Consumer activity eased off considerably in the fourth quarter. The higher dollar continued to exert a drag on exports. This was felt especially in the manufacturing sector.

An important question is whether to view the fourth quarter as a one-off aberration or a sign of slowing growth. Since we’re still in the first quarter of 2016, it’s a little early to come to a definitive conclusion. But we are able to gauge the strength of economic momentum in real time using a method we call a nowcast (as opposed to a forecast). A nowcast takes each data point as it comes in and adds it to a model-based computation of the growth rate of gross domestic product (GDP) on an annual basis. Such a computation is sometimes called a tracking estimate. The data we have in hand as input to this estimate run through January, with a few data points for February. Our tracking estimate for the first quarter is currently 1.9 percent.

So I am reasonably confident the first quarter will represent something of a bounceback from the fourth quarter of last year. Consumer activity has picked up sufficiently since the fourth quarter to support the view that overall domestic demand—the lead driver of the economy—is expanding at a healthy enough pace.

With a moderate pace of macroeconomic expansion in 2016 should come continued improvement in employment conditions. The headline rate of unemployment stands at 4.9 percent as of the last report. The employment report for February showed another small uptick of labor force participation, following earlier similar moves beginning last fall. I take this as an encouraging sign that potential workers previously out of the labor market are being enticed back into the labor force. Their return suggests that slack remains in our economy’s utilization of all potential labor resources, but we’re getting closer and closer to the objective of full employment.

The FOMC’s other policy objective is low and stable inflation. The rate of inflation has been too low for a long time, and the current run rate continues to be measured below the Fed’s target of 2 percent. Depending on the measure you use, inflation is running between two-tenths and eight-tenths of a percent below the desirable rate.

There have been encouraging aspects of recent inflation reports that suggest inflation may firm as we get to the back half of the year. Measures of inflation that exclude the direct price effects of energy prices and other relatively volatile consumer prices are not far below 2 percent. These data—taken with my assessment that the economy’s growth is still a bit above the longer-run potential rate—make me optimistic that the Committee’s inflation objective is achievable in the medium term.

In my opinion, the outlook for 2016 and into 2017 swings on the question of whether domestic demand will in fact hold up.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell