But data through mid-September generally indicate that the rise in rates has cut into the upward momentum of the housing sector. Currently, improving economic fundamentals versus fiscal drag and somewhat tighter financial conditions are pulling the economy in opposite directions, roughly cancelling each other. The economy continues to grow and payrolls are rising, but there is little evidence of a pickup in the economy’s forward momentum. For example, real GDP growth is still stuck close to the 2.2 percent average annualized growth rate that has prevailed since the beginning of the expansion. But, as the degree of fiscal drag and other headwinds lessen, the tug-of-war should begin to shift in favor of higher growth. Absent additional fiscal restraint, a further tightening of financial conditions, or some adverse external shock, I expect the economy to grow a bit faster in 2014. So, how compelling is this narrative? In big picture terms, it certainly seems quite reasonable to me. However, no forecast is inevitable and there are some reasons to remain wary. In particular, although the fiscal drag will likely lessen in 2014, I expect it will still be significant, and the outcome of the current federal budget and debt ceiling debates may affect this assessment. Moreover, when one drills down and looks at the recent performance and outlook for the economy’s major sectors, additional caution seems warranted. Turning first to the outlook for fiscal policy, there are two points worth making. First, the CBO projects that significant fiscal drag will persist into 2014.
The point I wish to emphasize is that any decisions on the pace of asset purchases (the rate at which we are adding accommodation) versus liftoff in terms of the federal funds rate (a tightening of monetary policy) should be viewed as largely independent of one another. One does not foreshadow the other – certainly not in any mechanical way or with a definitive timeframe. As Chairman Bernanke noted in last week’s press conference, our actions are data dependent and how the data will evolve is uncertain. In addition, it is worth explaining why we anticipate the federal funds rate is still likely to be quite low relative to what Committee participants consider normal over the longer run, even as the Committee gets close to its employment and inflation objectives. For example, in the September Summary of Economic Projections, the median projection for the federal funds rate in the fourth quarter of 2016 is 2 percent, far below the median long-run federal funds rate projection of 4 percent, at the same time that the unemployment rate and inflation are close to the Committee’s long-run objectives. How does one explain this? As noted by Chairman Bernanke in last week’s press conference, the still low federal funds rate projections for 2016 reflect the fact that economic headwinds – such as tight credit standards and ongoing fiscal consolidation – are likely to take a long time to fully abate.