Fed’s Brainard sees more headroom on U.S. interest rates

(Reuters) – The Federal Reserve may be able to push U.S. interest rates up gradually for another year or two without the higher borrowing costs putting the brakes on the current economic expansion, remarks from a key U.S. central banker on Wednesday suggested.

“With fiscal stimulus in the pipeline and financial conditions supportive of growth, the shorter-run neutral interest rate is likely to move up somewhat further, and it may well surpass the longer-run equilibrium rate for some period,” Fed Governor Lael Brainard said in remarks prepared for delivery to the Detroit Economic Club.

Brainard’s comments show she believes that stimulus from tax cuts and government spending are lifting the neutral level of interest rates above which higher borrowing costs slow investment and hiring, giving more headroom for the central bank to lift rates without impeding growth.

It is this shorter-run neutral rate, not the longer-run neutral estimate that is published each quarter by the Fed, that is the “relevant benchmark” for monetary policy, Brainard said. The Fed’s most recent estimate of the longer-run rate is 2.9 percent, about one percentage point higher than the Fed’s current policy target rate.

Most observers have taken this long-run rate to be a ceiling for Fed interest-rate hikes beyond which monetary policy would become restrictive, hindering growth.

Further gradual interest rate hikes are likely to be appropriate, she said, echoing recent comments from Fed Chair Jerome Powell and others.

But in the context of her belief that shorter-term neutral rates are likely to rise over the next year or two and surpass the longer-run estimate, those hikes look likely, at least in her view, to have more room to run.

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