Federal Reserve governor Lael Brainard on Tuesday called for a “cautious and gradual approach” to easing away from the central bank’s emergency stimulus efforts, suggesting that a variety of factors could necessitate low interest rates for a long time.
In urging the Fed to move slowly just two weeks ahead of a Fed meeting expected to result in the first rate hike in nine years, Brainard again suggested that she has a different, and more pessimistic view of the economy’s trajectory than does Fed chairwoman Janet Yellen.
Speaking at Stanford University, Brainard provided a number of reasons why this business cycle might feature a lower interest rate at a time when the economy is healthy, with no cyclical unemployment and inflation at the Fed’s 2 percent target.
One reason is that slowing growth in China and elsewhere overseas has put upward pressure on the dollar. Another is that slowing U.S. population growth and falling labor force participation have lowered expectations for growth. A third is that investors could still feel stung by the financial crisis, meaning more demand for low-risk, low-yield assets.
In the prepared text for her speech, Brainard noted that bond market prices suggest that the interest rate on a one-year Treasury bond in 10 years, long past the end of the recession, will be 1.3 percent, fully 2 percentage points below the average rate for that bond from 1999 to 2007.
Brainard provided a number of reasons for the Fed to be cautious about raising short-term interest rates from zero, including the fact that her estimate of the “neutral” rate of interest is not far above the actual zero rate right now. Nevertheless, most investors now view a December rate hike as highly likely.
She also provided ideas for what the central bank could do even if it does raise rates in December. In addition to raising rates only slowly, she suggested, the Fed should maintain its massive balance sheet as rates rise. The stimulus that comes from the Fed holding $4.5 trillion in assets would allow the Fed to raise rates faster, which in turn would facilitate rate cuts “if economic conditions deteriorate.”
If the balance sheet were instead wound down, fewer rate hikes would be possible and in turn fewer rate cuts would be available to Yellen and company should they want them.
Furthermore, she added, the Fed should use its new tools to prick financial bubbles that might inflate in the low-interest rate environment.
