The pace of the rate increase depends on how the economy reacts.  Reuters

The pace of the rate increase depends on how the economy reacts. Reuters

© Reuters. FILE PHOTO: John Williams, Chief Executive Officer of the Federal Reserve Bank of New York, speaks at an event in New York, USA, November 6, 2019. REUTERS / Carlo Allegri / File Photo

Author: Howard Schneider

PRINCETON, NJ (Reuters) – The Federal Reserve needs to move monetary policy toward a more neutral stance, but the pace at which it will tighten credit will depend on how the economy reacts, New York Fed President John Williams said Saturday.

In response to questions at the symposium on whether the Fed should accelerate its return to a neutral interest rate that neither encourages nor discourages spending, Williams noted that in 2019, with rates set close to neutral, “economic expansion has begun to slow down.” The Fed has resorted to cutting interest rates.

“We need to get closer to neutral, but we need to look all the way,” Williams said. “There’s no doubt in which direction we’re going. How fast we do it depends on the circumstances.”

Williams’ remarks point to a more cautious approach to the upcoming rate hike than has been forced by colleagues who believe the Fed should run towards a more neutral stance using higher-than-usual half-point rate increases in upcoming meetings.

The average estimate of neutral rate policy makers is 2.4%, a level that traders currently believe the central bank will reach by the end of this year. Such a pace would require a half-point increase to 2 of the remaining six Fed meetings this year, with the expectation that the first will come at the Fed session 3-4.

The Fed raised interest rates by a quarter of a percentage point last month, the start of what policymakers expect to be “steady increases” aimed at curbing inflation, which is currently tripled from the Fed’s 2% target.

At the last Fed meeting, the median policymaker projected a quarter-point increase in each meeting alone, but several have since said they are ready to move more aggressively if necessary.

The outcome depends on whether inflation calms down, Williams said.

“We expect inflation to fall, but if it doesn’t come … we will have to respond. I hope it doesn’t happen,” Williams said.

The Fed will also use another tool to tighten credit when it starts reducing its balance sheet size by nearly $ 9 trillion. Williams said it could start as early as May.

In remarks prepared at a Princeton University symposium, Williams said high inflation is currently the Fed’s “biggest challenge” and potentially further fueled by the war in Ukraine, the ongoing pandemic and the continuing shortage of labor and supply in the United States.

“Uncertainty about the economic outlook remains extremely high, and the risks to the inflation outlook are particularly acute,” Williams said.

However, he said he expected the combination of rising interest rates and shrinking balance sheets to help ease inflation to around 4% this year, and “close to our long-term 2% target in 2024”, while keeping the economy on track.

“These actions should allow us to manage the proverbial soft landing in a way that maintains a sustainable strong economy and labor market,” Williams said. “Both are in a good position to withstand tighter monetary policy.”

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