EUR 636.23 For Business Accounts Only

What’s Next For Monetary Policy Normalization?

** The Fed has raised rates seven times since December 2015. Economists and interest rate futures markets project a slowing in the pace of rate hikes in 2019 and there is increasing chatter about a pause once the funds rate hits some estimate of its short-run neutral level.

** Assessments of the neutral policy rate are often based on statistical models that are subject to material uncertainty. These estimates are also prone to revision, as evidenced by the recent significant upward revisions to the Laubach-Williams real equilibrium rate.

** We argue that monetary policy has not been tightened—it is important to differentiate between rate hikes and policy tightening—and we think 2018’s rate hike pace will be maintained in 2019. We also expect the peak fed funds rate will be close to the median projection of 3.4% in the June Summary of Economic Projections.

** We find arguments that the Fed is close to a “normal” balance sheet, given the upward pressure on the effective fed funds rate, unconvincing. We think it is unlikely that the Fed will take the balance sheet wind down off autopilot until there are signs of a significant deterioration in the economic outlook (though the normalization strategy might be adjusted help achieve the Fed’s goal of materially reducing the MBS share of its securities holdings).