Philadelphia Federal Reserve President Charles Plosser said Tuesday that if the economy continues to gain momentum and inflation moves higher it could prompt the central bank to raise interest rates sooner than forecast.
Plosser said the Fed’s current forward guidance, which it uses to forecast future policy decisions, may be “too passive,” meaning policy makers are underestimating how quickly the economy will reach various thresholds.
If the data continue to move at their current pace – namely, unemployment lower and inflation higher – than the Fed would need to raise interest sooner in order to ward off runaway inflation.
“My overall view of the economy is fairly optimistic,” Plosser said in prepared comments during a speech at the Economic Club of New York.
“After a first quarter buffeted by winter storms, I believe we are poised to grow at a rate somewhat above trend for the remainder of this year and next before reverting back to trend, which I see as about 2.4%,” Plosser said.
“Steady employment growth and healthier household balance sheets will underpin consumption activity. The current data suggest economic strength is fairly broad based, as witnessed by recent performance and the optimism expressed by firms in many manufacturing and service sectors,” he added.
The speech, however, points up a sharp divide among U.S. central bankers.
Plosser is an inflation hawk, or one of several Fed members who opposed much of the Fed’s interventionist policies in the wake of the 2008 financial crisis and who have called for a quick pullback from those policies.
Plosser said he had “growing concerns that we may have to adjust our communications in the not-too-distant future. Specifically, I believe the forward guidance in the statement may be too passive.”
The inflation doves, led by Fed Chair Janet Yellen, have endorsed a cautious approach toward ending the central bank’s easy money policies, namely a gradual tapering of bond purchases and keeping interest rates at their historic lows for the foreseeable future.
At last week’s meeting of the policy setting Federal Open Market Committee, the Fed lowered its short-term economic forecasts but slightly strengthened its long-term projections, leaving a mixed message.
The Fed barely changed its projections for where interest rates will stand at the end of 2015, but moved that projection higher for 2016, leaving markets confused as to exactly when rates might start moving higher.
Markets have been desperately searching for some clue as to when the Fed will pull the trigger and start moving rates higher.
Plosser is leaning toward sooner rather than later, while the doves seem to be maintaining their cautious approach.
Plosser also said the Fed should initiate a system that codifies how and when it plans to shift its policies, rather than leave markets guessing. If the Fed plans to keep interest rates low despite rising inflation, the Fed should be required to clearly explain the decision to do that, he said.