Philadelphia Fed’s Patrick Harker On Coming Interest Rate Hikes by [email protected]

Patrick Harker, president of the Federal Reserve Bank of Philadelphia, said “it’s not out of the question to still have one, possibly two” interest rate increases this year, though the recent weak jobs report has left the strength of the U.S. economy more open to questions. “We are at a point now where that jobs report gave us some pause. But I still think that the economy continues to be quite strong,” Harker noted in this wide-ranging [email protected] interview. Harker’s comments came during a two-day conference — “The Interplay between Financial Regulations, Resilience, and Growth” – sponsored by the Federal Reserve Bank of Philadelphia, the Wharton Financial Institutions Center, the Imperial College Business School and the Journal of Financial Services Research.

Harker’s views on the surprisingly weak May jobs report and potential for rate increases this year echoed those of Fed Chair Janet Yellen, who also cited financial market risks from a potential Brexit this week as notable reasons why the Federal Open Market Committee (FOMC) voted unanimously on June 15 not to raise interest rates. She reiterated many of those comments Tuesday and Wednesday before Congress. The FMOC meets again next month to reconsider whether an interest rate increase is needed now, and the next opportunity for an FOMC decision comes in September.

In Part 1 of this two-part series, Harker, a former Wharton dean, also discusses the limits of monetary policy; zero-bound and negative interest rates; the importance of education, innovation and infrastructure development for productivity; and a coming labor squeeze from Baby Boomer retirements that is threatening a slower, “new normal” U.S. growth rate. In Part 2 Harker discusses whether the Fed should be in the business of bursting asset or credit bubbles; ‘Too Big To Fail’ issues; shadow banking; fintech; and what surprised him during his first year as president of the Federal Reserve Bank of Philadelphia.

And edited transcript of the conversation follows:

[email protected]: This is an auspicious time to have President Harker with us because just a couple days ago [June 15] the FOMC made the decision not to change interest rates — although you won’t actually be voting until 2017. Correct?

Patrick Harker: Yes, next year.

[email protected]: I’m sure you have some views on it, and that’s what I’d like to ask you. How would you have voted this time around? It may be anti-climatic because as I understand the vote was unanimous. But what would have gone into your thinking, perhaps, is the better question?

Patrick Harker: A few weeks ago I gave a speech just across the street at the Constitution Center where I said that two, possibly three increases this year were not out of the question. And then we got the [May] jobs report. And I think that caused a pause, everybody stepped back a little bit to ask, “what’s going on?” It muddied the waters a little bit in my mind and here with our research staff, because it doesn’t quite add up, given everything else we’re seeing.

We are fully expecting that we will see a slowdown in jobs. As we reach full employment or maybe go lower than what the natural rate would be, it is natural that the [job growth] slows down. But we’re also seeing record job openings. The “quits” are still running high … we’re seeing other strength in the labor market.

“I think it’s not out of the question to still have one, possibly two [interest rate] increases this year.”

When you combine that with what we’re hearing through our contacts throughout the district [Federal Reserve Third District], most of Pennsylvania, and also Delaware and southern New Jersey]. And it doesn’t quite make sense. So the committee chose to not raise rates at that point. I still think … the U.S. economy … is incredibly robust…. If you step back and think about … the headwinds that we’ve been facing in a variety of ways, this is an economy that keeps chugging along. I wouldn’t say it’s robust. It’s not booming. But it keeps rolling along.

We keep adding jobs. We’re getting to a point where you will see the slowdown in the labor market a little bit. Part of the issue, by the way, with that jobs report and the unemployment rate kicking down a lot, was the participation rate dropping. And everybody saw that as an aberration.

I don’t see it that way. There’s work done here by Dr. [Shigeru] Fujita and others on our research staff where you look at the long-term secular trend of labor force participation — we’re heading toward a new normal, right, a lower level, just because of the baby boomers retiring. Although the labor force participation ticked up, it’s a bit of a stochastic process around that trend, but that trend is clear — that number is coming down.

And so we are at a point now where that jobs report gave us some pause. But I still think that the economy continues to be quite strong. If you look at inflation … we are heading toward our 2% target. Oil has solidified in terms of its price. In fact it may go up. It’s hard to predict. So we’re starting to see that transmit through the inflation numbers. And we are starting to see some wage pressures building, particularly for those who have stayed in the same job. Those folks are starting to get significant increases.

The other thing you’re hearing from contacts quite often is: People can’t find the qualified workers they need. And so there’s a bit of a job mismatch going on, a skills mismatch. There are a lot of jobs, but people can’t find the appropriate folks. You’re going to start to see that transmit through wage pressures as well. I think it’s not out of the question to still have one, possibly two [interest rate] increases this year.

[email protected]: There’s a counter argument out there, which found itself into the news just this week. It goes something like this: The U.S. economy hasn’t returned to full productivity compared with the pre-crisis period. In the first quarter this year, GDP was about 2.2% less than potential GDP. This is the so-called output gap.

And so the idea is … that there isn’t a lot of wage-price pressure. And in the absence of that, why not err on the side of allowing inflation to creep up a little bit because the Fed has excellent tools for combating inflation? The Fed knows how to take the punch bowl away.

“But I can tell you I hear from company after company after company, they cannot find skilled workers. That’s not just the tech companies. It’s across the board.”

On the other side, if growth slows too much, and there’s been worries about deflation, not so much in the U.S but in Europe and Japan, the tools have much less traction. So that argument is why, [when it comes to] talk about raising rates this year, why don’t we wait and until we have some real inflationary or wage pressures?

Patrick Harker: So obvious everybody in this room knows that the lag from when rates go up to where we see that effect is quite long, right – ‘18ish’

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