Significant fiscal stimulus this year is speeding the economy’s recovery so that the Federal Reserve is able to consider lifting interest rates from near zero by early 2023, said a top central bank official in a speech Tuesday.
Fed Vice Chairman Richard Clarida said he expects that, under his current projections for inflation and employment, “commencing policy normalization in 2023 would…be entirely consistent with our new flexible average inflation targeting framework.”
Mr. Clarida was a leading architect of the Fed’s new policy framework unveiled one year ago by Fed Chairman Jerome Powell. That framework calls for the central bank to seek periods of inflation moderately above its 2% goal to make up for past misses of the target.
The Fed’s framework wasn’t designed for an environment like the current one, where prices are surging due to bottlenecks and supply shortages associated with reopening the economy from the Covid-19 pandemic. That has complicated the Fed’s task of not only forecasting inflation but also of clarifying how it plans to react to incoming data about economic growth, unemployment and inflation.
In September 2020, the Fed said that so long as consumers’ and businesses’ expectations of future inflation remains stable, it will hold interest rates near zero until inflation is “on track to moderately exceed 2% for some time” and until the labor market reaches conditions associated with maximum employment.
Mr. Clarida prefaced his remarks by saying that interest rate increase are “certainly not something on the radar screen right now,” but he said that if his outlook for inflation and unemployment is realized, then the Fed’s thresholds for raising rates “will have been met by year-end 2022.”
The Fed’s new framework is aimed at addressing the problem the central bank faces of having less room to stimulate the economy once interest rates are lowered to zero, sometimes called the “effective lower bound” or “ELB.” In his speech, Mr. Clarida pointed to a burst of fiscal stimulus this year — something many forecasters at the Fed didn’t incorporate when they unveiled their interest-rate guidance in the second half of 2020.
“It is important to note that while the ELB can be a constraint on monetary policy, the ELB is not a constraint on fiscal policy, and appropriate monetary policy under our new framework, to me, must — and certainly can — incorporate this reality,” he said. Mr. Clarida said fiscal policy this year, including more than $2 trillion in excess savings that haven’t been spent by households, “can fully offset this constraint.”
Inflation has accelerated this year as the economy faces supply-chain bottlenecks and materials shortages. The Fed’s preferred inflation gauge, excluding volatile food and energy categories, rose 3.5% in June from a year earlier, compared with a 3.4% year increase in May.
Mr. Clarida said he expects inflation to decline next year, but that he expects it will still continue to run somewhat above the Fed’s 2% goal.
“I do continue to judge that these imbalances are likely to dissipate over time as the labor market and global supply chains eventually adjust and, importantly, do so without putting persistent upward pressure on price inflation, wage gains adjusted for productivity, and the 2% longer-run inflation objective,” he said. Mr. Clarida said he thinks the risks of inflation running higher than he currently expects are greater than the risks of inflation running lower than his forecast.