One of the biggest risks facing the economy? Washington, said Dallas Fed President Rob Kaplan on Thursday.
In an interview with MarketWatch, Kaplan said he was worried about policy, such as on trade or healthcare, that would cause consumers to pull back.
The renewed capacity of consumers to spend, eight years after the financial crisis, has been the “key underpinning” to the better economic outlook, he said. “We’re finally in a situation where the consumer capacity to spend is in pretty good shape,” said Kaplan, who is voting on the Federal Open Market Committee this year for the first time.
“I’m frankly more worried about and watching to make sure we don’t enact policies or some uncertainty that might cause consumers to take a little pause,” he said.
For instance, seniors may curtail spending if they see they may have to pay more for their health care.
“When you have windows where you can remove accommodation if you’re making progress, you should take advantage of those windows.”
Kaplan said he was also worried actions to roll back trade openness might cause U.S. jobs to be lost to Asia, especially if companies have to undo supply chains and logistics that have helped them become productive.
He didn’t specifically name President Donald Trump, who has talked about the need to get tougher on trade but hasn’t to date enacted policies to do so.
Kaplan defended the existing U.S. trade relationship with Mexico, saying it has improved U.S. competitiveness and added jobs.
“I’m hoping to see some segmentation of how we think about trade. We need that. We could actually hurt job growth,” he said. And any retaliation could costs jobs, he added.
Kaplan said Congress could also do positive things like cutting red tape and boosting spending on infrastructure. Corporate tax reform, if done right, might boost investment, he said.
The Dallas Fed president, who is a voting member of the Fed’s policy committee this year, said three interest rate hikes in 2017 is his “base case.”
Kaplan stressed that the Fed is being gradual and is not blind to headwinds. “Gradual and patient is the appropriate way to approach this,” Kaplan said.
At the same time, the Fed couldn’t be “so gradual” that the Fed might get behind the curve. That would cause the Fed to have to move more quickly, he said.
In a speech later Friday, New York Fed President William Dudley echoed this gradual theme, in somewhat more colorful language. He said the Fed wasn’t trying to be the chaperone that took the punch bowl away just as the party was getting going, but only adding “a bit more fruit juice” to the concoction.
“History has shown when you move more abruptly that’s tended to more likely than not cause a recession, which I think I’d like to avoid,” he said.
Earlier this month, the Fed raised rates to a range of 0.75% to 1%. Kaplan said he felt strongly the Fed should move in March so as not to get behind the curve.
“When you have windows where you can remove accommodation if you’re making progress, you should take advantage of those windows,” he said.
He said the strategy is to get interest rates up to the level where the central bank is neither stepping on the gas or pushing on the brakes. That rate is generally estimated to be around 2.5%-2.75%, he said. “The first order of business is to get to neutral,” he said.
Addressing another sensitive topic, Kaplan said the Fed could decide to shrink its balance sheet this year.
“As we get further along, it would be prudent to begin process of letting the balance sheet run off,” Kaplan said. He said the same gradual, patient pace would be appropriate. The Fed amassed a $4.5 trillion balance sheet during the crisis.
On inflation, Kaplan said he thought core inflation was “slowly ticking up” but “it may take awhile longer” to get to the Fed’s 2% target.
The forces that have been holding down prices “are not going away.”
Wage pressures are building, but the ability to transmit wage increases to prices is muted, he said.
“Everywhere I go in the district talking to people, wage pressures from what I can see are building,” he said.
Kaplan said the 2% target for inflation was not a ceiling. He said the Fed would just not tolerate “persistent” inflation above the 2% target.
The slowdown in bank lending this year is partially due to low demand, he added.
A market correction could be healthy – but not through interest rates
The Dallas Fed president said he did not think the Fed should use interest rates to pop asset bubbles. He said macro-prudential tools were much more appropriate if there was excess leverage.
A market correction “could be a healthy thing,” he said. The job of the Fed would be to “watch and observe,” he said.
Asked about the oil market, Kaplan said it was in a “fragile equilibrium.”
He said it still unclear whether OPEC would stick with production cuts in the face of some pickup in U.S. production.