December 31, 2014 / 8:14 PM / 3 years ago

Fed forecasting tool calls for immediate rate hike, Plosser says

Charles Plosser, president of the Federal Reserve Bank of Philadelphia, attends the Jackson Hole Economic Policy Symposium in Jackson Hole, Wyoming August 22, 2014. REUTERS/David Stubbs

(Reuters) - A forecasting tool developed by the Federal Reserve recommends that U.S. interest rates should be hiked immediately to keep pace with the improving economy, according to a paper by the soon-to-retire Philadelphia Fed President Charles Plosser.

Plosser, among the minority of hawkish monetary policymakers, co-published research showing the Fed-developed model calls for rates to jump from near zero to 0.5 percent in the fourth quarter of 2014, and to rise to 1.1 percent by the second quarter of 2015.

The paper was co-authored by Philadelphia Fed director of research Michael Dotsey, who is in the running to succeed Plosser once he steps down on March 1. It recommends a more aggressive tightening cycle than that predicted by the Fed’s core of officials, who generally see a mid-2015 hike and about a 1-percent federal funds rate by year end, if the economy continues to strengthen.

“We believe the economy has returned to a more normal footing and ... our benchmarking indicates that monetary policy should follow suit,” Plosser and Dotsey wrote.

The Fed is taking a more patient approach to its first rate hike in nearly a decade because U.S. inflation remains weak and the global economy is slowing. Fed Chair Janet Yellen suggested in December that no action will be taken for another few months.

Plosser, who has long argued for a rules-based approach to policy making, showed other more familiar forecasting models also call for an immediate tightening. Delaying “well into 2015 runs the risk of requiring more aggressive future monetary policy than would otherwise be needed,” he said in the paper.

The so-called Estimated Dynamic Optimization model, developed by economists at the Fed’s Board of Governors and used internally since 2006, gives a policy rule based on economic data through the third quarter and does not account for the recent plunge in oil prices.

It recommends a 2.8-percent federal funds rate by the end of 2017.

Reporting by Jonathan Spicer; Editing by David Gregorio

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