Fed’s Brainard Sees Reasons for Economic Optimism but Flags New ‘Crosscurrents’
Federal Reserve governor Lael Brainard signaled support for an interest-rate increase at the central bank’s meeting this month but flagged new headwinds that could complicate the economic and policy outlook next year.
“The most likely path for the economy is positive, although some tailwinds that have provided a boost are fading, and we may face some crosscurrents,” she said in prepared remarks for delivery Friday at the Peterson Institute for International Economics.
After prominently warning last year that subdued inflation warranted a more cautious approach to rate rises, Ms. Brainard’s economic outlook shifted earlier this year. In speeches this spring and summer, the economist endorsed a more determined path of rate increases due to new tailwinds from stronger global growth and stimulative fiscal policy during a period of low unemployment and stable inflation.
Ms. Brainard’s view Friday appeared to moderate somewhat from such bullishness. “There are risks on both sides of the economy’s likely path, ” she said. The Fed’s recent course of gradual short-term rate increases “has served us well by giving us time to assess the effects of policy as we have proceeded.”
Such an approach remains “appropriate in the near term, although the policy path increasingly will depend on how the outlook evolves,” she said.
Ms. Brainard said she saw “good reasons to expect economic growth to remain solid next year” and said she was comfortable that inflation showed little signs of veering too far above or below the Fed’s 2% target.
But she also warned that global growth and fiscal policy might not serve as tailwinds next year, and she noted that financial conditions had been less supportive for businesses in recent months, even though changes in the values of stocks, bonds and the dollar were still supporting economic growth.
Ms. Brainard devoted most of her speech to flagging worries about the growth in risky corporate borrowing and deteriorating lending standards that could make the next downturn more severe if over-indebted businesses retrench, leading to more defaults and layoffs.
Periods in which the unemployment rate has fallen below estimates of the neutral rate, or the level likely to persist over the long run, have yielded elevated risks of either financial imbalances or accelerating inflation, she said. With inflation modest, she highlighted the risks of the former.
Business borrowing has exceeded the growth in economic output for most of the expansion, rising to near its historical peak, she said. That has pushed the ratio of corporate debt to assets to within a 20-year high. Moreover, corporate balance sheets show that firms with more debt, higher borrowing expenses, and low earnings and cash holdings have seen the biggest debt increases.
Ms. Brainard warned that in a downturn, that could lead to fire sales of risky corporate debt, which could be amplified by changes in market volatility and liquidity. Such a scenario was “a possibility that has been relatively untested over the course of the expansion,” she said.
Policy makers should respond to these risks by increasing capital buffers for the largest banks, she said, as opposed to using interest rates to lean against potential instability.
Ms. Brainard’s colleagues on the five-member Fed board of governors don’t appear to share her enthusiasm for using a new tool to achieve this, called the countercyclical capital buffer. It would require the largest U.S. banks to sock away additional capital during good times so they have more to fall back on when loans go bad in downturns.
“Countercyclical capital requirements build resilience, unlike monetary policy,” she said.
Source: Dow Jones