Fed sees lower long-run interest rate outlook as growth dims

Bloomberg

Federal Reserve policy makers are discovering they likely need to shift into an even lower gear if they are to speed up the US economy. Chairman Jerome Powell and colleagues last week estimated that the so-called neutral interest rate — the level which neither stimulates nor restricts growth — now sits around 2.5 percent, down from 2.75 percent in March and as high as 4 percent in 2014.
That means the Fed’s current benchmark of 2.25 percent-2.5 percent is unlikely to provide the power policy makers once assumed it would, leaving eight of them anticipating they will have to reduce rates this year amid growing risks to the economic outlook. “This is really important,” said Torsten Slok, chief economist at Deutsche Bank Securities, who expects a rate cut in July. “For many years, the Fed has been arguing that monetary policy was easy and accommodative and supporting growth and inflation. After a decade of easy monetary policy, the Fed has decided that policy is no longer stimulative.”
Reasons listed for the lower neutral rate include ongoing fallout from the financial crisis, weaker productivity, continued slackness in the labour market and an aging population, which when combined leave the economy structurally weaker and so more vulnerable to rate hikes.
The upshot is the Fed may have to lower rates if it wants to boost expansion to offset global headwinds, including slow global growth and trade disruptions from President Donald Trump’s tariff battles.
Powell will give his view of policy in a speech on Tuesday to the Council on Foreign Relations in New York.

FUTURES CONTRACTS
Fed funds futures contracts are pricing in at least a 25-basis-point cut in July, with roughly 44 percent chance of a 50 basis-point cut. Those expectations for a steeper drop in the policy rate have grown in the days since Powell signaled a willingness to act swiftly “as needed” to protect the economy.
“They have come to the conclusion that growth is slowed by productivity and demographic factors that predate the Great Recession and that are not reversing soon,” said Jonathan Wright, a Johns Hopkins University economics professor and a former Fed researcher.
Trump has targeted US growth of 3 percent or more, a goal met last year because of fiscal stimulus including a $1.5 trillion tax overhaul. Kevin Hassett, outgoing chairman of Trump’s council of economic advisers, reiterated earlier this month he still expects 3 percent growth this year. “I’m not trimming it back,” he said on June 3.
Fed officials didn’t explain their reasoning in changing the forecasts in the Summary of Economic Projections. While some including Powell have said they hope tax and fiscal policies will boost productivity, their lowering of the neutral rate is a concession they are not expecting that to be sustained.
They estimate long-term growth at 1.8 percent to 2 percent.
“There was never going to be a big pickup in growth,” said Brad DeLong, an economist at University of California at Berkeley, who worked in the Treasury Department in the 1990s with Lawr- ence Summers, and like Summers has cautioned growth is in a period of “secular stagnation.”