NEW YORK CITY—New York Federal Reserve president William Dudley, regarded as one of the most influential members of the Fed's Board of Governors, said Monday he foresees continued gradual increases in the federal funds rate even as the Fed's 2% inflation benchmark remains elusive. Dudley made his observations, which also included an endorsement of making another rate increase this year, during an interview with the Associated Press.

“inflation won't get up to 2% very quickly on a year-over-year basis is because we've had these very low inflation readings over the last four or five months,” Dudley told the AP. Yet he added, “I think you'd want to continue to gradually remove monetary policy accommodation, even with inflation somewhat below target.”

For one thing, he said, “monetary policy is still accommodative, so the level of short-term rates is pretty low.” In addition, “financial conditions have been easing rather than tightening. So despite the fact that we've raised short-term interest rates, financial conditions are easier today than they were a year ago. The stock market's up, credit spreads have narrowed, the dollar has weakened, and those have more than offset the effects of somewhat higher short-term rates and the very modest increases that we've seen in longer-term yields.”

He cited the possibility of “structural, secular changes” in place that may be holding inflation lower on a sustained basis. “The distribution methods of how goods and services are provided have changed pretty dramatically,” he said. “It's possible that that could be putting downward pressure on inflation.”

If that's the case, Dudley told the AP, “that's not really a bad thing. That means we can actually allow the economy to operate at a higher level potentially of resource utilization.”

Dudley said that a third increase in short-term interest rates during the year “depends on how the economic forecast evolves.” If it evolves in line with his expectations, he said, “I would be in favor of doing another rate hike later this year.”

The New York Fed leader's economic outlook hasn't changed substantially since the beginning of the year. “I think we're still on the same trajectory we've been on for several years,” he told the AP. Accordingly, “Continue to look for growths around 2%, slightly above trend, growth sufficient to continue to tighten the labor market.”

The low-rate environment has been a constant for so long that the specter of asset bubbles is on people's mind. For instance, former Fed chair Aslan Greenspan recently warned that bond prices would collapse as rate hikes continued. In the near term, though, Dudley didn't share this concern, although he pointed out that the Fed keeps an eye on possible misalignment of asset prices and economic fundamentals.

“I think the financial system is a much, much stronger place today than it was prior to the financial crisis and the Great Recession,” said Dudley. “Banks have more capital, they have more liquidity” as the Fed has corrected “some of the structural weaknesses in the financial system.”

Pointing out that he didn't think it was reasonable to assume that “the Federal Reserve is somehow going to manage financial asset prices so that they are completely stable over time,” Dudley nonetheless said that the central bank was on the lookout for potential problem areas. “What we have to be cautious of is making sure that the financial system is robust, so that if there is weakness in financial asset prices, it doesn't contribute to a great stress in the financial system, which then spills into the real economy, to try to avoid what happened during the Great Recession,” Dudley told the AP.

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If that's the case, Dudley told the AP, “that's not really a bad thing. That means we can actually allow the economy to operate at a higher level potentially of resource utilization.”

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Dudley Sees Gradual Rate Hikes Continuing

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