Fed official expects rates to go up

The Federal Reserve should drop the word "patient" from its interest rate policy language at this month’s meeting and begin having "serious discussions" in June about raising rates, a top policymaker said Wednesday.

San Francisco Federal Reserve Bank President John Williams said in an interview with the Honolulu Star-Advertiser on Wednesday that the decision when to raise interest rates should be "data driven" and that the first increase and subsequent moves should be in quarter-point increments.

Interest rate decisions by the Fed greatly affect the U.S. economy because they play a big role in everything from determining how much consumers pay for their mortgages and car loans to how much interest they earn in their bank accounts.

After keeping its key short-term rate near zero for six years, the Fed must now maneuver a difficult transition from keeping rates low to beginning to raise rates without triggering a volatile reaction in financial markets that have grown used to ultra-low rates.

Fed Chairwoman Janet Yellen testified before Congress last week that the Fed can remain "patient" in deciding when to begin raising rates. The word "patient" means a rate hike is unlikely for at least the next two Fed meetings, she said. The Fed will hold meetings in March, April and June. If it drops the word "patient" at the March meeting, as Williams advocates, it could begin raising rates as soon as June.

"My view is in terms of this ‘patient’ language — in terms of the March meeting — is that we have to kind of back away from that because it suggests that we’re not going be raising rates for quite some time and we want to move to a much more data-dependent description of policy," said Williams, who is in Honolulu to speak Thursday at the 10th annual economic forecast dinner of the Chartered Financial Analyst Society of Hawaii at the Hawai‘i Convention Center.

With the economy improving, the Fed should be making decisions on a meeting-by-meeting basis but is hamstrung because the "patient" language means that the Fed won’t raise rates for the next two meetings, Williams said.

"If we kept ‘patient’ language in March, it means we’re unlikely to raise rates in either April or June (the next two meetings), and if we remove the ‘patient’ language it would leave June as a possibility for raising rates," said Williams, who is one of 10 members on the Federal Open Market Committee, which decides rates.

For six years, the Federal Reserve has kept interest rates low and purchased trillions of dollars in bonds to revive the American economy. It’s been nine years since the Fed increased rates.

Williams said the Fed hasn’t forgotten how to tighten monetary policy.

"We still have that muscle memory," he said. "We still know how to do that."

Yellen told Congress the U.S. economy has been making steady progress toward what the Fed defines as "maximum employment" — an unemployment rate between 5.2 percent and 5.5 percent. The January unemployment rate was 5.7 percent and February’s rate will come out on Friday.

With inflation low and the job market still not at desired levels, Yellen told Congress that the Fed can be "patient."

Williams said he’s in no rush to raise rates and has no problem with the Fed’s policies. But he said all the evidence from the past shows it takes at least a year or two for monetary policy to have its full impact on the economy and on interest rates.

"So what I’m looking at is not what the inflation rate was over the last 12 months or even the last six months, but given the strength of the recovery and given that I think we’ll be at full employment by the end of the year, where is the economy going to be a year from now?" he said. "You need to basically take your foot off the gas before you reach your objective and remove some of this accommodation before you get there. If we wait all the time until inflation gets to 2 percent and unemployment is below 5 percent then I think we’ll be in a situation where we’d have to kind of reverse course quickly and that would create some issues and risks to the recovery. My view is that we have to act in advance of reaching our goal."

However, Williams added that the Fed can take its time raising rates.

"I see this as a gradual process over a few years of removing accommodation as appropriate," he said.

Williams said whether or not rates are increased in June or in a subsequent meeting, he expects the Fed to pull the trigger by the end of the year.

"My own view is that we should be raising rates by the end of the year based on my own forecast of unemployment being like 5 percent and inflation probably being about 11⁄2 percent, moving up to 2 percent. So I think by the end of the year it will be pretty convincing that we’re on a path toward our goals, and given this lag for monetary policy that you have to act in advance, it would be time to do this."

The amount of the increases, Williams said, should be in "baby steps."

"I expect a very gradual pace of increase," he said.

The Associated Press contributed to this report.