Short-term U.S. growth should help inflation get closer to the U.S. Federal Reserve's 2% target, but long-term trends could mean the central bank will have to adjust its expectations for prices, Federal Reserve Bank of Dallas President Robert Kaplan said.
Aided by recent tax legislation, GDP growth should get to a range between 2.5% and 2.75% this year, Kaplan said May 15 at the Council on Foreign Relations in New York.
But an aging workforce and technological change will be obstacles to productivity, with growth slowing to 1.75% to 2% by 2021, he said.
That means that the path of rate hikes the Fed should follow to get to a neutral rate of inflation will be slower, Kaplan said.
"If you asked me 10 years ago what’s the neutral nominal rate [of inflation], I would say that’s between 4% to 5%,” he said. “Today, it’s 2.5% to 3%, because prospects for future GDP growth are sluggish."
Over the next 12 to 18 months, the issue will be what the Fed should do when it gets to a neutral rate, Kaplan said, adding that the central bank should have "gradual and patient removals of accommodation, including reducing its balance sheet."
Kaplan predicted that the Fed’s balance sheet would eventually hold somewhere between $2 trillion and $3 trillion, mostly in Treasurys.
The Fed has raised rates once already in 2018 to a range between 1.5% and 1.75% and is expected to raise rates at least twice more, with the next rate hike expected in June.
Though some economists predict a fourth rate hike, Kaplan said raises should be gradual, saying: "I would rather make that judgment later in the year."
Kaplan is not a voting member of the Federal Open Market Committee this year.
Though he expects oil prices to stabilize in the short term — the price of Brent is up about 22% this year to around $78 per barrel — Kaplan said that in three to five years, the Dallas Fed expected oil prices to strike a "fragile equilibrium," because it was doubtful that shale could keep up with global demand.
"The spike risk is to the upside" in the longer term, he said.
The Dallas Fed chief also weighed in on the renegotiation of the North American Free Trade Agreement, noting that the trading partnerships with Mexico, and to a lesser extent with Canada, were developed over the past 20 to 25 years.
Because those partnerships mostly involve intermediate supply chains, they benefit the U.S. economy and workforce, Kaplan said, adding: "If we don’t have [NAFTA], we will likely lose share to Asia."