As Fed Prepares to Raise Rates, Economists Caution of Potential Bumps

By Ben Leubsdorf 

        BOSTON--Federal Reserve officials and economists are warning about potential turbulence as the central bank moves to raise interest rates this year for the first time in nearly a decade.
        "If we do it right, we don't put the economy off-kilter," said Federal Reserve Bank of Boston President Eric Rosengren. But "there are unusual conditions that I think complicate the normalization of rates this time."
        For instance, the current low level of long-term interest rates "indicates that there may be a bumpier ride, just because there needs to be an adjustment at some point along the cycle," he said.
        Still, Mr. Rosengren and others who spoke over the weekend at the American Economic Association's annual meeting in Boston expressed relief that the U.S. economy has healed to the point where officials can seriously consider their first rate increase since 2006.
        It is remarkable, said New York University economist Mark Gertler, that "after six or seven years, we're finally talking about policy normalization, and it's not a hypothetical conversation."
        The Fed has kept its benchmark short-term interest rate pinned near zero since December 2008, through six years of the financial crisis, recession and slow recovery. Now, with the U.S. experiencing robust growth and strong hiring, the central bank is preparing to start pulling back its support.
        Nearly all Fed policy makers predicted in December that the first rate increase will come this year. The precise timing and pace, though, remain up in the air. Officials must weigh an improving labor market against sluggish inflation that has undershot the central bank's 2% annual target for more than 2 1/2 years. The fall in global oil prices likely will drag inflation down further in the coming months.
        The Fed in December pledged to be patient and Chairwoman Janet Yellen said it was unlikely the Fed would begin raising rates at its next two policy meetings, scheduled for Jan. 27-28 and March 17-18.
        Mr. Rosengren, in his remarks Saturday, said patience in raising rates is justified given low inflation and slow wage growth.
        Other officials may favor swifter action. Federal Reserve Bank of Cleveland President Loretta Mester could see rates rising in the first half of this year, she said Friday during an interview on Fox Business Network.
        How the Fed communicates its intentions could smooth, or roil, the process, Harvard University economist and former Fed governor Jeremy Stein said during a Saturday panel discussion. He pointed to the recent wind-down of the Fed's bond-buying program: Initial signals in mid-2013 sparked market volatility, but the actual process of reducing bond purchases was relatively uneventful.
        "How you manage the communication about a given amount of tightening or change in policy may be more important than the change itself, sometimes, " Mr. Stein said.
        In any case, any turbulence as the Fed tightens should feel mild compared with the turmoil of the 2007-09 financial crisis, Mr. Gertler said. "The ride up could be a little bumpy, but nothing in comparison to what the ride down was," he said.
        Write to Ben Leubsdorf at ben.leubsdorf@wsj.com
        (END) Dow Jones Newswires

        January 04, 2015 17:07 ET (22:07 GMT)
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