Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
US financial stability could be threatened if the Federal Reserve keeps borrowing costs too low and allows an overheating jobs market to encourage excessive risk-taking, a senior US central banker has warned.
Eric Rosengren, the president of the Federal Reserve Bank of Boston, argued for short-term interest rates to be lifted toward neutral levels, which neither boosts nor holds back the economy, or even higher.
“We do need to be concerned about financial excesses,” Mr Rosengren said in an interview with the Financial Times, noting that “boom-bust cycles” in the labour market had ended badly in the US.
Given its limited regulatory toolkit for curbing financial imbalances, the Fed should be willing to “lean against the wind a little” by lifting the cost of borrowing, he added.
Concerns that America’s economic boom could lead to hazardous risk-taking in financial markets have begun to feature more prominently in Fed discussions, as the US experiences above-trend growth at a time when tax cuts and public spending rises are fuelling the economy. A number of Fed officials including chairman Jay Powell and Lael Brainard, one of the governors, have said the central bank needs to keep a close eye on financial conditions.
Speaking during a visit to Washington on Thursday, Mr Rosengren, who has recently been among the more hawkish of the Fed presidents, said the central bank would not know how high rates needed to be pushed until they had got to neutral levels.
I don’t think we can provide guidance when it is not as clear what we are actually going to do
His estimate for the neutral rate of interest stood at the upper end of Fed projections, which lie between 2.5 per cent and 3 per cent.
But he added: “If the economy is growing when we get to 3 per cent then I wouldn’t necessarily stop just at 3 per cent — if it is growing strongly enough that I think labour markets are going to tighten and inflationary pressures will pick up.”
The Fed is gearing up for a further rise in short-term interest rates from the current range of 1.75-2 per cent in its September 25-26 meeting, with more tightening possible in December and next year as unemployment hovers well below Fed estimates of sustainable levels.
Mr Rosengren, who is not a voter on the Federal Open Market Committee this year but will be in 2019, said that after a few more rate rises it would become harder to predict where policy would go, meaning the central bank would not be able to offer much guidance to markets.
“I don’t think we can provide guidance when it is not as clear what we are actually going to do,” he said.“You can imagine getting at a point after a few more tightenings where there is going to be less certainty about what the next move would be.”
Among the steers that the Fed currently provides markets are assurances that policy will remain “accommodative” and that moves will be “gradual”.
While consumer price inflation numbers on Thursday had been a little soft, Mr Rosengren said the Fed was for all practical purposes at its 2 per cent inflation target. If the labour market keepstightening for the next six months, which seemed likely, it would be necessary to start asking if strongerwages would start to be reflected in higher prices, meaning the US gets “an inflation rate we are less comfortable with”, Mr Rosengren argued.
The trade tensions could add to those inflation pressures, he said. “At a time when tariffs are going up there may be an opportunity in a tight labour market for firms to more easily pass on price increases.”
The Fed had bitter experience with allowing the jobs market to get well beyond its estimate of full employment, he explained.Research by Mr Rosengren and his colleagues Jeffrey Fuhrer, Giovanni Olivei and Geoffrey Tootell, shows a clear postwar pattern of recessions happening after joblessness falls below its sustainable rate.
“We have essentially no success historically in guiding the unemployment rate back to full employment without going well past that and getting into a recession,” Mr Fuhrer said.
On the financial stability side Mr Rosengren stressed he did not see some kind of “gigantic bubble that is obvious to everybody”. But there were parts of the market where conditions seemed a “little bit easy” and where people were taking on more risk. Among the areas in the Fed’s spotlight are commercial real estate and sections of the corporate debt market.
The US did not have as broad a macroprudential toolkit as other countries such as the UK when it came to curbing financial booms, said Mr Rosengren, who has advocated that the Fed boosts the so-called countercyclical capitalbuffer to ensure banks are more resilient.
“If we don’t have those other tools I would use monetary policy to lean against the wind a little bit,” he said. “That is one reason I don’t want to overshoot far beyond what I think full employment is — because one of the ways it tends to manifest itself . . . is through higher inflationary pressures, but other times it reflects itself in financial stability issues. We have to take both of these into account.”
