Federal Reserve Governor Susan Schmidt Bies said Monday that the central bank must be alert to rising inflationary pressures, although "measured" interest rate increases could keep it well contained as the economy grows at a solid pace.
"Though inflation pressures have risen somewhat in recent months, longer-term inflation expectations appear to have remained well contained," Bies said during a speech at Canisius College.
"I believe that, while underlying inflation is expected to continue to be low, the Federal Reserve must be more alert to monitoring incoming data, and continue to remove policy accommodation at a measured pace, consistent with the incoming data and its commitment to maintain price stability," she said.
"The most important way to create long-term growth is to keep inflation low and stable," said Bies, a member of the Fed's policy-making Federal Open Market Committee.
Bies, a Buffalo native who graduated from Kensington High School and Buffalo State College, also said that rising interest rates should not have a significant impact on businesses, which have taken advantage of several years of unusually low interest rates to refinance more costly debt and lock in their borrowings at low rates over long terms. Other firms use hedging to mitigate the impact of rising rates.
"As interest rates do start to move up, we're going to see a slow impact when it hits companies because they've locked in for such a long time," Bies said. "In my view, even with a rise in interest rates and some moderation in profit growth, the business sector should remain financially strong and continue to expand."
Further putting businesses in a position to withstand rising interest rates is their push in recent years to cut costs and boost productivity, which has improved profitability at many firms.
"To be sure, the profit share likely will slip a bit from its high level as the expansion gains steam and businesses hire new workers more aggressively," Bies said. "But some decline in the profit share is to be expected and will not, in my view, significantly impair the financial health of companies."
Bies also downplayed concerns that rising household debt levels, which grew at a 10 percent annual rate from 1999 to 2004, might force consumers to rein in their spending as rates rise.
"Consumers can more afford the debt they've taken on because the low interest rates have taken their payments down," Bies said.
Most of the surge in debt is due to rising mortgage borrowing, fueled by historically low mortgage rates, strong growth in housing prices in most other parts of the country and higher home ownership rates.
With more homeowners refinancing the mortgages to take advantage of lower rates, more than half of those borrowers took out cash in those new loans to pay down higher rate debt. As a result, the lower rates on those combined borrowings and the longer term of the loan has reduced the monthly payments that homeowners are required to make on their borrowings, she said.
"To be sure, some households will be pressured by the higher rates, but I believe that concerns about their effect on repayment burdens can be overstated," she said.
Bies also cited "troubling" trends in retirement savings among Americans, with a quarter of all workers not participating in 401(k) savings plans, even if their employers match a portion of their contributions.
A 2003 survey by Deloitte and Touche found that workers at a quarter of the firms surveyed saved an average of less than 4 percent of their pay for retirement. Bies also noted that workers continue the risky practice of concentrating their retirement savings in the stock of the company they work for.
"The average consumer, based on the average 401(k) funds, clearly aren't making the right choices for themselves," Bies said. "They don't understand the importance of asset allocation and changing that mix over the lifetime of that account,"
However, Bies said "promising changes," such as "opt-out" 401(k) plans that automatically enroll all workers, unless they specifically choose to withdraw from the plan, can lead to sharply higher participation rates. Default investment options that funnel a worker's money into a diversified portfolio that automatically adjusts its allocation of stocks and bonds as a worker ages also can help, she said.