The Federal Reserve raised interest rates last week but left its rate outlook for the coming years unchanged even as policymakers projected a short-term jump in U.S. economic growth from the Trump administration’s proposed tax cuts.
Fed policymakers judged it would boost the economy next year but leave no lasting impact, with the long-run potential growth rate stalled at 1.8 percent. The White House has frequently said its tax plan would produce annual GDP growth of 3 percent to 4 percent.
The expected fiscal stimulus, coming on the heels of a flurry of relatively bullish data, cleared the way for the U.S. central bank to raise rates by a quarter of a percentage point to a range of 1.25 percent to 1.50 percent. It was the third rate hike this year.
But the Fed’s forecast of three additional rate increases in 2018 and 2019 was unchanged from its projections in September, a sign the tax legislation moving through Congress would have a modest, and possibly fleeting, effect.
The rate increase represented a victory for a central bank that has struggled at times to deliver on its promised pace of monetary tightening. It also allowed Fed Chair Janet Yellen, at her final press conference before her term ends in February, to signal an all-clear for the U.S. economy a decade after the onset of the 2007-2009 recession.
“At the moment the U.S. economy is performing well. The growth that we’re seeing, it’s not based on, for example, an unsustainable buildup of debt … The global economy is doing well, we’re in a synchronized expansion,” Yellen said. “There is less to lose sleep about now than has been true for quite some time, so I feel good about the economic outlook.”
But the central bank’s projections also contained some potential dilemmas for incoming Fed chief Jerome Powell.
The Fed now envisions a burst of growth, ultra-low unemployment of below 4 percent in 2018 and 2019 and continued low interest rates – yet little movement on inflation.
Yellen said the persistent shortfall of inflation from the Fed’s 2 percent goal was the major piece of “undone work” she was leaving for Powell to figure out.
In its justification for last Wednesday’s rate increase, which was widely expected by financial markets, the Fed’s policy-setting committee cited “solid” economic growth and job gains.
“Changes in tax policy will likely provide some lift to economic activity in coming years,” Yellen said, adding that “the magnitude and timing of the macroeconomic effects of any tax package remain uncertain.”
The impact would “mainly” work to raise aggregate demand as households and companies have more money to spend, Yellen said, with “some potential” to raise investment and the economy’s longer-term growth.