This week marked the end of the Fed’s hopes for a normal economic recovery and the beginning of an acknowledgment from the central bank that a return to “normal” interest rates might never happen.
It’s not that Chairwoman Janet Yellen and company foresee the economic recovery petering out. Fed officials, in their newly released projections, still see growth picking up the rest of this year after a weak first quarter and the unemployment rate still falling.
But their latest projections and statements envision weaker global growth and rule out the possibility of a robust recovery like previous ones, in which the Fed raises rates steadily and predictably in meeting after meeting to keep up with the rapid recovery. It’s a view shift that comes nearly eight years after the financial crisis and just months before an election that will be shaped largely by voters’ perceptions of the economy.
In her quarterly media briefing on Wednesday, Yellen twice referred to the “new normal” reflected in the Fed’s latest projections for a significantly slower series of rate hikes over the next few years: slower, yet steady, growth, but interest rates held down by some combination of low productivity, fears about overseas economic risk and demographic slowdown.
Analysts were surprised that the Fed could mark down its projected interest rate hikes given that, apart from a weak May jobs report, not much changed between when the Fed last updated its projections in March and now.
If it wasn’t incoming data that changed the Fed, it was instead a “sea change” in Fed officials’ way of thinking, according to University of Oregon economist Tim Duy, speaking on Bloomberg TV.
Federal Reserve Bank of St. Louis President James Bullard wrote in a paper released Friday that the post-crisis way of thinking at the Fed, that the economy was bound to spring back to its previous full health at some point, had “likely outlived its usefulness.”
Goldman Sachs economists Zach Pandl and Jan Hatzius wrote that the Fed’s decision and projections were “arguably a partial adoption of the secular stagnation hypothesis,” referring to the theory advanced by Harvard professor and former Obama adviser Larry Summers. Summers has speculated that the economy may be suffering from a persistent lack of demand for goods and services that may not be self-correcting.
The immediate implication for the U.S. is that, even with continued ultra-low rates from the Fed, the economy should not be expected to roar back, especially not before the November elections.
“Three percent growth — gone as an idea,” Societe Generale global strategist Kit Juckes said Friday in an interview with Bloomberg Surveillance. “This is the Fed accepting the new normal as the growth prospects. We’re in a world where 2 percent growth is kind of as good as it gets.”
