NEW YORK (Reuters) - Policymakers need to add stimulus early to deal with too-low inflation when interest rates are near zero and cannot wait for economic disaster to unfold, a Federal Reserve policymaker said on Thursday.
In a speech read as a strong argument in favour of quick and aggressive action by the Fed to cut rates when it meets at the end of this month, New York Fed President John Williams said one lesson from his research is that when rates and inflation are low, policymakers cannot afford to keep their “powder dry” and wait for potential economic problems to materialize.
That is especially true with neutral rates that would neither restrict nor accelerate the U.S. economy “around half a percent,” he said. When adjusted for inflation, the neutral rate is near the Fed’s current policy rate, which is in a range of 2.25-2.50%.
“It’s better to take preventative measures than to wait for disaster to unfold,” Williams said in a speech at a central banking conference in New York. “When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress.”
A New York Fed representative said the speech was academic in nature, based on 20 years of research, and “not about potential policy actions” at the Fed’s rate-setting meeting on July 30-31.
Still, short-term bond yields dived on the remarks, with 2-year Treasuries US2YT=RR falling below 1.78% from over 1.81% seconds earlier. Interest-rate futures spiked, pricing in higher chances of a larger Fed rate cut sooner, and broad U.S. stock indexes traded at their highs for the day.
In recent weeks, Fed policymakers have identified a host of concerns they think could end what is now the longest U.S. economic expansion on record. Chief among the concerns are the U.S.-China trade war, which is denting business confidence, a global manufacturing slowdown and inflation below the Fed’s target of 2% a year.
Williams, who is a permanent voting member of the Fed’s policy setting committee, sounded particularly concerned about inflation, with the Fed’s preferred measure of prices gaining 1.6% a year now.
“People may start to expect it to stay that way, creating a feedback loop, pushing inflation further down over the longer term,” he said. “The lower average level of inflation translates into a lower level of interest rates cuts available during a downturn, making it even harder for policymakers to achieve their goals.”
Taking quick action to cut rates in the face of “adverse economic conditions” and keeping rates lower for longer, Williams said, “should vaccinate the economy and protect it from the more insidious disease of too-low inflation.”
Reporting by Trevor Hunnicutt; Editing by Chizu Nomiyama and Leslie Adler