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Without mentioning President-elect Donald Trump by name, Federal Reserve officials warned that the incoming administration’s fiscal policy must be intelligently designed to spur the economy while maintaining a rainy-day fund to help the economy withstand another downturn.
“Smart” government spending and tax reform could help the economy grow, said Chicago Fed President Charles Evans in a speech to the Executives Club of Chicago, according to Reuters.
Earlier, New York Fed President William Dudley had said fiscal policy should be aimed at cushioning the next downturn even though the economy is “in reasonably good shape” at the moment and downside risks have been reduced by the prospect of stimulative fiscal policy by the new Congress.
“It is … important that the U.S. retains sufficient fiscal capacity so that fiscal policy can support the economy when the next cyclical downturn does occur,” he said in a speech to a business group.
At the moment, according to Dudley, there is “considerable uncertainty” about how fiscal policy will evolve under the Trump administration and the Republican Congress. “We don’t know what the fiscal policy is, we don’t know how big it is and we don’t know when it is actually going to occur,” he said.
In general, if fiscal policy turns more expansive and supports activity, the Fed would probably raise interest rates more quickly, he said.
Dudley said he was in favor of infrastructure spending that lifted the productive capacity of the economy.
Still, the supply of funds for promised tax cuts and infrastructure spending isn’t endless, he warned.
The retirement of the baby boomers is putting pressure on government-entitlement programs. And the government’s debt-service costs will grow as interest rates rise, Dudley said.
“Consequently, significant pressures on the federal budget are still very much in train,” he said.
For his part, Dudley especially called on Congress to put in place spending programs that would be automatically triggered by an economic downturn. For instance, Dudley said extensions of unemployment compensation and cuts in payroll taxes could be triggered by a downturn.
Such “stabilizers” would be helpful because “they would come in place much more quickly and people could count on then,” Dudley said in an interview with CNBC after his speech.
New spending at the right time would also take pressure off the Fed to undertake additional unconventional monetary policy to boost the economy, he said.
“It is important that monetary policy and fiscal policy work together and not at cross purposes to be able to bolster the economy when it needs support,” he said.
Financial markets have shifted since the election with stocks and bond yields rising and the dollar DXY, -1.09% strengthening.
Dudley said that his “personal interpretation” of the market moves was that investors anticipate that fiscal policy will turn more expansionary and the Fed will likely respond by raising interest rates “a bit more quickly than anticipated.”
“Assuming this expectation is realized, the recent modest tightening in financial-market conditions seems broadly appropriate,” he said.
Dudley said the tightening in financial conditions was not a “great concern.” A rising dollar that stems from investors thinking the domestic economy is healthier is a “positive element,” he said.
Investors are reacting to better chances of stronger demand and lessened downside risk, not risk aversion, he said.
Dudley said “sturdy” job gains and firming wages meant the Fed was not far from its two goals for interest-rate policy — maximum employment and stable prices.
He said that he expects further economic progress next year and that, as a result, a gradual pace of interest-rate hikes is appropriate.
via HSN