Janet Yellen: ‘The magnitude and timing of the macroeconomic effects of any tax package remain uncertain’ © Reuters
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Donald Trump says US tax cuts will fuel a growth miracle. As the Federal Reserve gave its first formal response to the Republican reforms on Wednesday, it was clear the central bank foresees a far more modest impact.
Presiding over what was likely to be her final quarter-point rate rise as Fed chair, Janet Yellen outlined stronger growth forecasts of 2.5 per cent this year and next as well as a lower unemployment outlook but she played down the implications of tax cuts for monetary policy.
The changes moving through Congress would provide “some modest lift” to gross domestic product growth, she said, with the package holding the potential to boost consumer and capital spending. She noted, however, that tax reform was “only one of a number of factors” affecting the outlook for growth and inflation.
“While changes in tax policy will likely provide some lift to economic activity in coming years, the magnitude and timing of the macroeconomic effects of any tax package remain uncertain,” she said.
Many economists see the Republicans’ deficit-boosting fiscal package as poorly timed, given the economy is at full employment and US public debt is already heading inexorably higher. Going into the Fed’s meeting, some had expected US central bankers to react by pencilling in a more aggressive path of rate rises in a bid to push back against unneeded and potentially risky stimulus.
Far from seeking to clamp down, however, the Fed stuck to existing median forecasts for three rate rises in 2018 and another two in 2019.
Ms Yellen stressed that the existing “gradual” path of rate rises remained appropriate even with almost all of the Fed’s policymakers now factoring in the effects of the tax cuts, in a sign that officials are happy to bank any extra growth rather than rein it in.
“The Fed in effect pocketed the fiscal stimulus for the time being as an added insurance against weak underlying inflation,” said Krishna Guha, vice-chairman of Evercore ISI, the research group.
Ms Yellen may have charted out a steady course on Wednesday but the reality is that the path of rate increases is set to become murkier after Jay Powell, her successor as Fed chair, takes over in February.
Ms Yellen said on Wednesday that the Federal Open Market Committee expected the pace of job growth to slow as the US hovered at full employment. But if the jobless rate instead carries on falling rapidly, the central bank may find itself having to tighten more quickly to prevent the jobs market from overheating.
The Fed already expects unemployment to fall below 4 per cent in 2018 and 2019 and some Fed policymakers predict joblessness to fall as low as 3.5 per cent — breaching the tech-boom trough of the late 1990s and early 2000s.
At the same time, asset prices are at elevated levels and some investors worry the easy money policies being pursued are stoking future trouble in the financial system.
Ms Yellen insisted no warning lights were flashing on financial stability. But returning persistently sub-target inflation to 2 per cent while tamping down on any risk of the labour markets or asset prices overheating will be a big challenge for Mr Powell.
On top of this, the central bank faces an intense period of churn at its top levels, with key appointments pending including the vice-chair of the board of governors. By this time next year the central bank will look like a very different organisation — at least in its uppermost ranks.
This uncertainty could prove jarring for traders accustomed to steady and generally predictable monetary policy under Ms Yellen for the past four years. Her final scheduled press conference was a characteristically deft performance, steering clear not only of market mishaps but also political tripwires.
That meant Ms Yellen avoided unnecessary political scuffles on sensitive topics such as the Republicans’ fiscal package, and her tone on tax was strikingly even-handed. Any growth uplift from the tax cuts would be “very welcome” to policymakers, she said, even as she stressed that it would be “challenging” to achieve the kind of growth rates Donald Trump has been brandishing.
The chair’s clear goal, said Diane Swonk of DS Economics, was to hand the Fed over to Mr Powell in as smooth and seamless a fashion as possible.
It is something she remains on track to achieve. “She knows how to walk on shifting foundations — both political and economic,” said Ms Swonk.