By Ann Saphir
The modest pace of U.S. economic growth in recent years suggests that when the time comes to raise interest rates the Federal Reserve will be able to do so gradually without fear of a sudden surge in inflation, a top Fed official said on Wednesday. Many economists, both at the Fed and outside, had expected the economy to roar back after the Great Recession, requiring a rapid tightening of policy at some point, Fed Board Governor Daniel Tarullo told a dinner forum in Washington, D.C.
But because that never happened, he said, "It seems less likely that we will experience a growth spurt in the next couple of years that would engender concerns about rapid wage pressures and changes in inflation expectations."
In a departure from his area of expertise, financial regulation, Tarullo's speech was about the long-term challenges for the American economy, including slowing productivity and rising income inequality. He said monetary policy could lay the groundwork for improving the potential growth%VIRTUAL-pullquote-"The policies that have been pursued have been essential to assure that moderate pace of recovery, but they've also ... not created the kind of recovery that everybody would have preferred."% rate by reducing labor market slack.
"The policies that have been pursued have been essential to assure that moderate pace of recovery, but they've also ... not created the kind of recovery that everybody would have preferred," he said. The recovery, however, looks "reasonable well grounded" as it progresses, Tarullo added.
Some Fed officials have speculated that damage to the economy from the recession has changed the structure of the labor markets, so that undesirable wage pressures could kick in even when unemployment is well above its historical norm of about 5.5 percent. But because it is difficult to know just how much slack there is currently in the labor markets, Tarullo said on Wednesday, "We are well advised to proceed pragmatically."
While the Fed should be attentive to signs that wage pressures are rising, "We should not rush to act preemptively in anticipation of such pressures based on arguments about the potential increase in structural unemployment in recent years," he said. Many Fed officials appear to agree with Tarullo that rate rises, once they start, can be gradual, with the median forecast from the Fed's 16 current policymakers suggesting that rates are likely to be around 2.25 percent by the end of 2016, well below the historical norm of 4 percent.
Tarullo added that the Fed's monetary stimulus has had "demonstrable" positive effects on rate-sensitive sectors of the economy such as housing and automobiles.
By Ann Saphir