The Economy "Has Its Own Momentum"


Kansas City Federal Reserve Bank President Tom Hoenig has a reputation in the financial markets as a bit of an anti-inflation hawk. In a central bank that puts a premium on consensus, he dissented twice in 2001 against cutting interest rates (see BW Cover Story, 7/5/04, "What Keeps Greenspan Up at Night").

Hoenig, whose bank sponsors the Fed's annual Jackson Hole (Wyo.) get-together, spoke on June 4 with BusinessWeek Senior Writer Rich Miller about the outlook for the economy and interest rates. Edited excerpts of their conversation follow:

Q: The Labor Dept. reported that nonfarm payrolls rose 246,000 in May, following gains of 346,000 in April and 353,000 in March. What's your reaction?

A: I'm pleased with these numbers. A 300,000 increase in jobs per month for a little while, given where we started, isn't necessarily out of line. The economy is strong. It has its own momentum now. Barring shocks, we should see growth of at least 4.5% this year. And given the job numbers, given the improvement in incomes that should come with [the better employment picture], we should continue to see fairly good growth in 2005.

Oil is kind of the wild card. We like to refer to it as a tax on the consumer. It does have a constraining influence. But at this stage it's not going to impede the basic strength of the economy going forward.

Q: We've had a bit of a bump up in inflation this year. How worrying is that?

A: We have seen some increase. Part of it is due to higher energy prices as they work through the economy and to commodities generally. But we still have an environment of relatively modest inflation. The thing that we don't want to do is give that up.

The markets understand that monetary policy right now is highly accommodative. It needs in some fashion to move back toward a more neutral position. The challenge ahead is to move in a way that helps contain inflationary expectations, yet doesn't impede the strength of the economy. We're in a favorable position to do that and do it, as our statement said, in a measured fashion, because inflation is modest.

What that measured fashion will be will depend on how events evolve, and how the economy's strength evolves over the course of the year. We'll watch the inflation numbers very carefully.

Q: You talk about moving the 1% federal funds rate back to a more neutral level. What's the neutral level?

A: If you look at a real [inflation-adjusted] rate at 2% to 3% and look at inflation as somewhere around 1.5% to 2.5%, you can define what your neutral rate is. Now, that's based on historical averages. In the short run, there are a whole host of factors that cause you to want to be above or below that number. That's why I'm cautious with my words and say move back toward neutral. If we say 4%, then everyone says that will be the target rate. Well no, it depends on how the economy evolves.

Q: Over the past year, the Fed has been much more explicit about its future interest-rate plans, first saying it would keep rates low for a considerable period, now saying it will increase rates in a measured fashion. What's behind that?

A: The goal here was to be as open and forthright as we could, given the circumstances -- to say "here's our policy, here's what we think" and not surprise the market.

Q: So such forward-looking statements will be a permanent feature in the future?

A: I'd like to keep my opinions open for now. It does have the effect of tying you [down] to some degree. If you say this is what you're going to do, you have some obligation to do it. We need to assess whether on balance it has been beneficial.


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