Sunday, September 17, 2017

Another Crisis? Fed's Dudley Does Not See One Coming

New York Fed CEO William C. Dudley gave a speech recently in New York outlining how he sees things going in the US economy. Notably absent is any mention of concern that the US might see any kind of new major crisis any time soon or that markets are in an overvalued bubble condition. 

In fact, Mr. Dudley says he thinks things are going pretty well and that the Fed should be able to stay on course to shrink its balance sheet in the months ahead. He adds that he does not think the shrinking of the balance sheet is likely to have much impact. Below are excerpts from the introduction and the concluding remarks sections of the speech.  

"Good evening.  It is a pleasure to have the opportunity to speak at this Money Marketeers event.  In my remarks, I will focus on two topics:  1) The economic outlook and the implications for monetary policy, and 2) the Fed's balance sheet normalization process, which is likely to begin relatively soon.  As always, what I have to say reflects my own views and not necessarily those of the Federal Open Market Committee (FOMC) or the Federal Reserve System.
Overall, the economy remains on a trajectory of slightly above-trend growth, which is gradually tightening the U.S. labor market.  Over time, this should support a rise in wage growth.  When combined with a firmer import price trend-partly reflecting recent depreciation of the dollar-and the fading of effects from a number of temporary, idiosyncratic factors, that causes me to expect inflation will rise and stabilize around the FOMC's 2 percent objective over the medium term.  In response, the Fed will likely continue to remove monetary policy accommodation gradually.  But, the upward trajectory of the policy rate path should continue to be shallow, in part because the level of short-term interest rates consistent with keeping the economy on a sustainable long-run growth path is likely to be considerably lower than it was in prior business cycles. 
The process of balance sheet normalization-in which an increasing proportion of maturing Treasuries and agency mortgage-backed securities (MBS) repayments are allowed to run off the Fed's balance sheet-should also exert some monetary policy restraint over time.  But, I believe this impact will be quite modest.  Not only is this shift in policy now widely anticipated, but we have also seen that the impact on the level of long-term interest rates has been small as expectations have adjusted."

. . . . 

"To sum up, I expect that the U.S. economy will continue to perform quite well, with slightly above-trend growth leading to further gradual tightening of the U.S. labor market.  As this occurs, I would anticipate that wage growth will firm and that price inflation will gradually rise.  In response, I expect that we will continue to gradually remove monetary policy accommodation.  Balance sheet normalization will likely be part of this process.  But, we expect this to have only a mild impact and to run passively in the background.  Short-term interest rates will remain the primary tool of monetary policy."

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