Exploring the Economy’s Recent Progress, and the Implications for Policy

“As long as the balance sheet reduction is not steep, it should have only modest effects on credit markets – in other words it can be gradually reduced ‘in the background,'” Rosengren said. “That will allow Fed policymakers to focus primarily on gradual normalization of the federal funds rate, using it as the primary vehicle for attaining sustainable growth, full employment, and price stability at 2 percent inflation.”

Calling weaker-than-expected first quarter economic data “probably a temporary lull,” Rosengren noted the strength of the April labor market report, GDP growth likely to exceed 2 percent for the remainder of the year, and measures of inflation near the Fed’s 2 percent target. Rosengren said in his view it is important that the Federal Reserve continue to gradually normalize interest rates, and also to begin to normalize the central bank’s balance sheet.

Echoing previous concerns about creating an “over-hot economy,” Rosengren said most forecasters are expecting growth above potential, and unemployment rates below his estimate of full employment. This, he said, would represent an unsustainable, “overshooting” pace for the economy – and provides an important rationale for continuing the process of normalization of monetary policy that is currently underway.

“My primary message today is about the importance of achieving positive, but long‐run sustainable, economic conditions – full employment and stable prices – and, by extension, that monetary policy supports such an outcome.”

Rosengren acknowledged potential risks to the forecast – including around bank lending and risks from abroad. But, while bank loan growth has not been as robust as in previous cycles, this likely reflects the nature of the crisis, recession, and recovery rather than a particular weakness in underlying economic conditions. And the risk of a slowdown from abroad seems to be abating as of late.

Exploring the stance of policy, Rosengren said U.S. monetary policy remains “quite accommodative,” while economic conditions are now consistent with full employment and the Fed’s inflation target.

Noting that the median forecast among Fed policymakers is for two more increases for this year, Rosengren said his own view “remains that along with a gradual reduction in the level of the balance sheet, it would still be reasonable to have three rate increases over the remainder of this year, assuming the economy evolves like my forecast envisions.”

Rosengren was speaking to the Lake Champlain Regional Chamber of Commerce and the Central Vermont Chamber of Commerce, in South Burlington, Vermont.