Low inflation will not stop the Federal Reserve from beginning to shrink its $4.5 trillion balance sheet next month, but will likely force it to delay further interest-rate hikes until December or even beyond, a U.S. central banker said on Wednesday.
“I personally think that it would be quite reasonable to (begin trimming the Fed’s balance sheet) in September on the basis of the data that I’ve seen so far, even with the potentially temporary lower inflation data,” Chicago Federal Reserve Bank President Charles Evans said in an interview at the bank’s headquarters.
But while Evans has supported both of the Fed’s rate hikes this year, a third remains a subject for discussion.
“What I’ve just outlined would put on the table in December possibly one increase, but if you thought that inflation was weaker and we needed more accommodation you could decide to put that off until later,” said Evans, who has a vote on the Fed’s policy-setting committee this year.
The opposite, he acknowledged, could also be true: inflation could start heading toward the Fed’s 2-percent goal faster than he currently thinks, pushed by an economy growing more smartly than the 2.25 percent to 2.5 percent pace he expects for the next few years. But, he said, that’s not his expectation.
Advances in technology have been pressing down on inflation, but the table is set, he said, for those one-time factors, like a large decline in cell phone plan costs earlier this year, to recede. Businesses have been loath to raise wages, but as the unemployment rate sinks further—its latest reading, in July, was 4.3 percent—they may have to, particularly to attract workers with the technical skills they need, Evans said.
Still, Evans has long been an advocate of erring on the side of delay when it comes to raising rates, because he fears that raising rates when the economy is not ready for it could reverse the slow but substantial progress it has made since the Great Recession.
So it is notable that he wants to get on with balance sheet reductions, even though prices are not rising nearly as fast as the Fed deems healthy. The Fed’s balance sheet is as big as it is because it bought trillions of dollars of bonds in an effort to boost inflation and the economy.
But Evans said the balance sheet reduction will have little impact on financial markets because it has been so well telegraphed, and that it was important to begin because it will take three to four years before the size of the balance sheet returns to normal proportions. His view appears to be broadly similar to that of his colleagues.
Where Evans may differ, however, is in his view of inflation, which has slipped further away from the Fed’s 2-percent goal in recent months.
“The longer that we stay below that I think it creates a few more problems,” he said. “I’d like to see a little more evidence that we are actually getting to 2 percent sooner rather than later.”