A top Federal Reserve official said that he sees a "reasonable case" to raise short-term interest rates this month and that any new fiscal stimulus approved by lawmakers in Washington could shape the central bank's expectations for additional rate increases next year.
New York Fed President William Dudley said in an interview Thursday that any effort to make the tax code less complex "makes sense." But with the economy expanding solidly and the unemployment rate at a low level of 4.1%, Fed policy makers will be watching closely to see whether any tax changes might cause the economy to overheat.
"It would be a reasonable question to ask, is this the best time to apply fiscal stimulus, when the economy's already close to full employment?" he said. "It's probably not the best time."
Both the House and Senate tax overhaul bills under consideration would cut taxes for businesses and many individuals, which could spur households to spend more and companies to invest more.
The Fed has raised its benchmark short-term rate three times this year in quarter-percentage point steps to a range of between 1% and 1.25%. Mr. Dudley said he agreed with an assessment earlier this week by Fed governor Jerome Powell, President Donald Trump's nominee to be the Fed's next chairman, that the case for another such move in December was "coming together."
At their September meeting, Fed officials penciled in one more rate increase this year and three next year, but that was before Congress moved closer to an agreement on tax-cut plans of around $1.4 trillion over 10 years.
Mr. Dudley said it was premature to judge how any fiscal policy changes would influence interest-rate decisions. Still, with unemployment at or below the level many Fed officials believe should spur higher inflation, any tax changes would be an important development for them to consider as they update their forecasts. They want the tight labor market to drive inflation up to their 2% target, but don't want price pressures to rise uncontrollably beyond that level.
"If I were to judge that the tax-cut package would push the economy along very rapidly without raising the productive capacity of the economy, then that would obviously factor into my own thinking on monetary policy," Mr. Dudley said.
The current tax proposals appear to be a "mix" of the type of efficiency-boosting overhaul he supports and the more straightforward stimulus, he added.
More broadly, Mr. Dudley said the economy is doing well and the prospects for the expansion continue to "look very, very good." While low bond yields, credit spreads, and high stock-market valuations suggest "maybe there is a little bit more risk in the markets" than normal, Mr. Dudley said he didn't think asset valuations were "grossly inconsistent" with the economy's performance.
"This is an above-average economic environment, and in an above-average economic environment, I would expect asset values would be above average as well," he said. While policy makers need to be "more alert to overheating in terms of the real economy," Mr. Dudley said the financial system is also more resilient to shocks today than it was before the 2008 financial crisis.
Although the unemployment rate has fallen this year below levels forecast by Fed officials, inflation has also been puzzlingly soft. The Fed's preferred inflation gauge, excluding volatile food and energy categories, rose 1.4% in October from a year earlier, below the central bank's target. Mr. Dudley said he wasn't overly concerned about the shortfall.
"The fact that the inflation rate is a little bit below 2%, I don't think it is a huge problem," he said. "I think it's a moderate problem, because obviously you don't want to stay here indefinitely."
Mr. Dudley has announced he plans to retire in mid-2018 once his successor is named.
He said he didn't want to prejudge how the central bank's rate-setting Federal Open Market Committee would respond if the unemployment rate kept falling further.
"I don't think many people around the FOMC table would think that a 3% unemployment rate would turn out to be sustainable," he said.
At the same time, he said, without signs of wage acceleration, the Fed can afford to be patient.
"We have to be sort of agnostic about what the full employment rate is, and update our views based on what's actually happening to wages, and how that's actually feeding through to prices," he said.
Write to Nick Timiraos at email@example.com
(END) Dow Jones Newswires
December 01, 2017 22:44 ET (03:44 GMT)