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Fed Predicts Modest Economic Growth From Tax Cut

Janet L. Yellen on Wednesday at what is expected to be her last news conference as Federal Reserve chairwoman before stepping down early next year.Credit...Eric Thayer for The New York Times

WASHINGTON — The Federal Reserve, buoyed by a steadily strengthening economy, raised interest rates on Wednesday for a fifth time since the financial crisis and predicted that a proposed tax cut moving through Congress would modestly increase economic growth for the next few years without stoking inflation.

As a result, the Fed said it did not expect the legislation, which President Trump has called “rocket fuel” for the economy, to accelerate the Fed’s plans to raise interest rates in 2018 and indicated it remains on track for three rate increases next year.

The Fed’s highly anticipated economic assessment, delivered after a two-day meeting of its policymaking committee, amounted to a lukewarm endorsement of the Trump administration’s top economic priority. Mr. Trump has suggested that the $1.5 trillion tax cut could nearly double economic growth to as much as 6 percent, a level far greater than most economists think likely.

“My colleagues and I are in line with the general expectation among most economists,” said Janet L. Yellen, the Fed’s chairwoman. She said they expected the bill to provide “a modest lift.”

Ms. Yellen spoke at a news conference after the Fed announced a widely expected decision to increase its benchmark interest rate by a quarter of a percentage point, to a range of 1.25 percent to 1.5 percent. The increase continues the Fed’s gradual march toward higher rates, which were cut to near-zero during the financial crisis. Wednesday’s increase is the third time this year that the Fed has raised rates, reflecting its confidence that the economy is in good health.

The Fed and Congress are moving in opposite directions. The Fed, in raising rates, is reducing the support it has provided to the economy since the financial crisis. Congressional Republicans, meanwhile, are preparing a $1.5 trillion tax cut for businesses and individuals with the aim of stimulating economic growth.

Some Fed officials, including Ms. Yellen, cautioned earlier this year that tax cuts could push the pace of growth to an unsustainable level, resulting in higher inflation, and that the Fed might respond by raising interest rates more quickly, to restrain growth and keep a lid on inflation.

After seeing the details of the tax plan, however, Fed officials have concluded that there is no need to raise rates more quickly. A quarterly update of the Fed’s economic forecast showed that officials still expect to raise rates three times next year — unchanged from the last economic forecast.

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A worker at an Amazon warehouse in New Jersey. By raising rates for the third time this year, Federal Reserve policymakers signaled their confidence that the economy is in good health.Credit...Lucas Jackson/Reuters

“We continue to think that a gradual path of rate increases remains appropriate even with almost all participants factoring in their assessment of the tax policy,” Ms. Yellen said on Wednesday.

In part, the Fed has concluded the tax plan doesn’t pack a large punch. Fed officials predicted that the economy would grow at a 2.5 percent pace next year; the previous forecast was 2.1 percent.

President Trump has predicted that the tax plan could deliver 4 percent growth or more.

Apprised of those comments by a reporter, Ms. Yellen responded: “I wouldn’t want to rule anything out. It is challenging, however, to achieve growth of the levels that you mentioned.”

The Fed also has learned that it’s not so easy to increase inflation, which has remained persistently low despite a tightening labor market and strengthening economy. The Fed aims to keep prices rising by 2 percent a year; it is on pace to undershoot that goal for the sixth straight year, and Fed officials on Wednesday predicted a seventh consecutive failure in 2018.

But the Fed’s outlook is also politically convenient, even if some analysts described it as overly optimistic. Republicans argue that the tax cuts will deliver a lasting boost to economic growth by encouraging investment. They do not want the Fed to get in the way by raising rates.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, described the Fed’s forecast as “hopelessly unrealistic.” He noted that the Fed was predicting that growth would be stronger than it expected, and unemployment would decline further, but without any increase in inflation.

“In short, the Fed forecasts an endless expansion, with minimal inflation pressure,” he said.

It would be relatively easy for the Fed to respond if inflation does begin to climb. A thornier problem is the concern voiced by a minority of Fed officials that the central bank is already raising rates too quickly.

Two Fed officials voted against Wednesday’s rate increase: Charles L. Evans, president of the Federal Reserve Bank of Chicago, and Neel Kashkari, president of the Federal Reserve Bank of Minneapolis. Mr. Evans has argued that the Fed may be holding down inflation by undermining public confidence that it will raise inflation back up to 2 percent.

The Fed’s rate increases have had little impact on financial markets, which have also shrugged off the Fed’s efforts to tighten borrowing conditions. Rates on many loans have declined since the Fed’s most recent rate increase, in June, and credit terms have loosened. Lee Ferridge, head of North American macro strategy for State Street Global Markets, said Wednesday’s decision was “a bit of a nonevent, quite honestly.”

Asset prices, which have climbed strongly this year even as the Fed has raised rates, were largely unchanged on Wednesday. The Standard & Poor’s 500-stock index dropped 0.1 percent, closing at 2,662.85. The yield on the benchmark 10-year Treasury fell to 2.34 percent from 2.4 percent on Tuesday.

Mr. Ferridge said the ongoing stimulus campaigns by other central banks, notably the European Central Bank and the Bank of Japan, were offsetting the effect of the Fed’s retreat.

“You’ve still got huge amounts of liquidity coming into the system, and that’s what’s driving markets,” he said. “You’ve got the Fed tightening, but you’ve got global policy loosening.”

Some economists see the lack of tightening in financial markets as a reason for the Fed to raise rates more quickly, to prevent the formation of bubbles that could cause economic disruptions.

Ms. Yellen played down such concerns on Wednesday. She said the Fed saw little evidence that a fall in asset prices would cause broader pain. The use of borrowed money, for example, remains relatively modest by historical standards. “When we look at other indicators of financial stability risks, there’s nothing flashing red there or possibly even orange,” she said.

The Fed’s rate increases also haven’t had much impact on the domestic economy.

The average interest rate on a 30-year mortgage loan, at 3.94 percent last week, was lower than the 4.13 percent average rate at the same time last year, according to Freddie Mac.

But Ruben Gonzalez, an economist at Keller Williams, the real estate franchise based in Austin, Tex., said he expected mortgage rates to start rising gradually.

Mr. Gonzalez noted that housing prices were rising, and he said that higher mortgage rates could worsen affordability problems in some markets. “Any time rates are trending upward, and prices are growing at a rapid pace, affordability is going to be a big conversation,” he said.

The next round of monetary policy decisions will be made by a new group of leaders.

Ms. Yellen is scheduled to step down in early February, at the end of her four-year term. Mr. Trump has nominated Jerome H. Powell, a Fed governor, as the next chairman. He is awaiting Senate confirmation. Only one of the nine voting members of the monetary policy committee at the beginning of this year is expected to remain a voting member by the middle of 2018.

Ms. Yellen on Wednesday praised Mr. Powell as “somebody who understands the Federal Reserve very well and shares its values,” and she said she would work to ensure a smooth transition.

Asked about her own legacy, she described her time at the Fed as “immensely rewarding.”

“I feel good that the labor market is in a very much stronger place than it was eight years ago,” she said.

Follow Binyamin Appelbaum on Twitter @bcappelbaum.

A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: Fed Expects Tax Cut to Give Economy ‘a Modest Lift’. Order Reprints | Today’s Paper | Subscribe

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