Fed’s Rosengren warns against running U.S. economy above capacity

By Lindsay Dunsmuir

WASHINGTON (Reuters) – The best way for the U.S. Federal Reserve to prolong the nation’s economic expansion is to pursue a monetary policy path where the economy does not run above capacity, Boston Fed President Eric Rosengren said on Wednesday.

Rosengren, who has said the U.S. central bank would probably need to raise interest rates a total of at least four times this year, also repeated his call for the Fed to consider adopting an inflation range target instead of a specifically targeted rate.

The Fed currently has a 2 percent inflation target.

“I think the policy path that will increase the probability of a longer recession-free period is the path where the economy does not run above capacity and, thus, fall far below the sustainable unemployment rate,” Rosengren said in prepared remarks for a speech at the Peterson Institute for International Economics in Washington.

The U.S. unemployment rate fell to an 18-year low of 3.8 percent in May, which is below what Fed policymakers believe to be a sustainable level. They see the longer-run unemployment rate at 4.5 percent.

The Fed has raised rates twice this year and forecasts another two hikes by the end of this year. It has raised borrowing costs seven times since it began a tightening cycle in December 2015.

The central bank’s benchmark overnight lending rate, or fed funds rate, is currently in a range of 1.75 percent to 2.00 percent.

There is uncertainty within the Fed about how far and fast to further raise rates. Most policymakers back a policy of gradual rate hikes and the median forecast for the so-called neutral rate – the level that neither boosts nor contracts the economy – is 2.9 percent.

That gives the Fed less room to maneuver than in the past in terms of cutting rates when another economic downturn occurs.

Rosengren noted the Fed can do little to change the longer-run neutral rate, which is affected by factors such as productivity and an aging population, and so must turn to other methods.

A different inflation framework could help the central bank avoid hitting a zero interest rate level, he said.

“One might allow the inflation target to rise within the range during periods of low real rates, thus providing more room for the funds rate to fall during an economic downturn,” Rosengren said.

Many policymakers have also backed a review of the Fed’s current inflation framework, but so far Fed Chairman Jerome Powell has shown no urgency to do so.

Rosengren is not a voting member of the Fed’s rate-setting policy committee this year.

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