This week, New Zealand became the first Western economy to raise interest rates since European Central Bank did so nearly three years ago in an attempt to avert a debt crisis.
This is significant because so many countries — above all, the United States — have been slow to begin inching back towards normal central-bank policies.
At a conference sponsored by the Global Interdependence Center this week, Charles Plosser, president of the Federal Reserve Bank of Philadelphia, put the Fed’s extraordinary monetary pump-priming into perspective. Its expansionary policies have made the economy “all about the Fed,” he said, and have “sent signals to financial markets to ignore fundamentals.”
Now that the Fed has finally begun to “taper,” or reduce the rate of its expansion, Plosser told attendees a real question about the Fed’s huge balance sheet. “Do we have a sufficient range of tools to manage the exit that is not disruptive to financial markets and the economy in general?” he asked. “We just don’t know how effective the exit will be.”
Plosser said the Fed may have to increase the pace of tapering to take into account a rise in near-term economic forecasts. Real output in the second half of 2013 grew 3.3 percent, up from 1.8 percent in the first half of the year. At the current pace, the Fed will end the purchase program later this year.
What concerned Plosser the most over the long term was what might be called the New Normal of the U.S. economy. He noted that the Congressional Budget Office recently reduced its estimate of long-term economic growth to 2 percent from 2.5 percent. This slowing down of projected growth may have a dramatic impact on everything from paying for entitlements to reducing long-term unemployment. Plosser said potential economic growth is “probably now permanently lower than we thought in 2007.”