Friday, 31 July, 2015
WSJ Hils:GDP Data Support a Soon-and-Slow Rate Hike Strategy
U.S. gross domestic product numbers released Thursday conform to the Federal Reserve’s view that the economy stabilized after a disappointing first quarter, and thus likely keeps the central bank on a path to raise short-term interest rates as early as September.
The report makes it more likely that the Fed’s growth forecasts will hold up for 2015. With the Commerce Department’s upward revisions to first quarter output, the economy needs to grow at a 2.3% pace in the second half of the year to reach the Fed’s projection of 1.9% growth for the year as a whole, said Roberto Perli, an economist at research firm Cornerstone Macro. The Fed will update its forecasts for the economy in September and it is in a better position to act if it isn’t revising down growth projections.
Consumer prices, excluding food and energy, rose at a 1.8% annual rate in the second quarter. That is below the Fed’s 2% target but firmer than earlier months and firmer than many private analysts expected. It thus helps Fed officials gain confidence that inflation is stabilizing and could be poised to inch higher from low levels. The annual rate of core inflation was 1.3%, in line with the Fed’s projection for the year. Again, it will help officials make an argument for a rate increase if they don’t have to revise projections down in September.
The latest growth numbers factor into longer-term strategic issues facing the central bank. Revisions to earlier data show the economy expanded at a 2% pace between 2012 and 2014, 0.3 percentage point less than prior estimates. This supports the view that the economy has emerged from financial crisis with an exceptionally slow underlying growth trend. The fact that the jobless rate is falling at a time of very slow economic growth supports the diagnosis that the economy has low growth potential, a function of slow worker productivity growth and labor force growth. Slack in labor markets can get eaten up quickly in this kind of environment.
How should the Fed respond to an economy with low growth potential? Mr. Perlie said it supports the view that the Fed might want to start raising interest rates soon – to prevent inflation pressures from building as slack recedes — but then proceed at a very slow pace because a slow-growing economy can’t bear very high rates.
“Because potential growth is lower than normal, you proceed at a pace that is lower than normal and you stop (raising rates) sooner,” he said.
-By Jon Hilsenrath
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