(April 12 – 18:15 ET) – The U.S. Federal Reserve is raising rates because “aggregate demand has been growing faster than potential aggregate supply,” board governor Laurence Meyer said in a speech before the Toronto Association for Business and Economics earlier today. Output has reached its limit and, “quite possibly, the economy is operating beyond the point of sustainable capacity”.
Meyer says the Fed has been less aggressive than he’d like. “Policy has been somewhat less pre-emptive than it otherwise might have been, and somewhat more willing to tolerate increases in output”.
Although the Fed maintains that it isn’t targeting stock prices, it has strong concerns over the wealth effect of strong markets. “Higher equity prices have boosted household wealth and increased consumer spending relative to disposable income, says Meyer. Higher equity prices have also reduced the cost of capital and reinforced the investment boom.” This in turn has boosted demand, he says.
The Fed will continue to use monetary policy to try to keep a demand imbalance from getting out of hand and sparking inflation. Meyer says until there are big moves in the economic data the Fed will likely stick with a gradualist approach to policy. “Policymakers have to adjust the timing and cumulative size of tightenings to ensure that the effect on overall financial conditions will promote a continuation of this economic expansion and an accompanying low and stable rate of inflation,” he says.