– Some Ready To Tighten; Others Hoping for More Disinflation Evidence
– Alternative Policy Scenarios for Curbing Inflation Being Assessed
By Steven K. Beckner
(MaceNews) – The week after a hotly debated Federal Open Market Committee decision to hold short-term interest rates steady has brought comments from multiple Federal Reserve officials suggesting that the Fed’s policymaking body could be primed to raise rates before long unless inflation continues to trend lower.
While some officials sound ready to raise the federal funds rate at the FOMC’s mid-September meeting, others may take more convincing. All will be closely examining the inflation and other data that will be coming between now and then.
As last Wednesday’s 9-3 FOMC vote suggests, Fed officials diverge on how best to proceed, but in their comments since then, they agree that the Fed’s main priority must be to bring down inflation to the central bank’s 2% target.
As New York Federal Reserve Bank President John Williams put it Monday, “There’s a debate about how do we best achieve our goals, but there’s absolutely no debate about the importance of achieving maximum employment and price stability.”
Williams led off a parade of Fed officials this week in declaiming on their monetary policy viewpoints after a divided FOMC left the federal funds rate unchanged for its fifth straight meeting.
The FOMC vice chairman, who voted with the majority to leave the funds rate where it is for another six weeks, repeated his familiar refrain about policy currently being “well-positioned,” but he seemed to add an edge to his comments to Reuters by saying, “It would absolutely be appropriate to act” if inflation doesn’t get “on a trajectory that does bring inflation back to 2%.”
Fed Governor Lisa Cook voted to hold rates steady, but served notice Wednesday that she’s ready to raise them “if (she does) not see signs of continued disinflation soon.”
Philadelphia Fed President Anna Paulson, who also voted to keep the funds rate unchanged, stopped well short of calling outright for higher rates Tuesday, but warned that if inflation remains “stubbornly elevated,” such a lack of progress would mean “more restrictive policy is needed.”
Minneapolis Fed President Neel Kashkari, one of three Fed presidents who dissented in favor of higher rates, not surprisingly called again for immediate tightening Wednesday.
An assortment of non-voters offered various degrees of conditional support for higher rates if inflation fails to moderate. Some were more reticent than others.
Most recently, St. Louis Fed President Alberto Musalem said Thursday evening that it is “crucial” for the Fed to put “meaningful restraint” on inflation and seemed to overtly contradict new Fed Chairman Kevin Warsh’s belief that lower interest rates to encourage productvity gains can lower inflation in the long run.
That “would be a mistake,” he asserted.
Kansas City Federal Reserve Bank President Jeffrey Schmid was more bluntly hawkish Tuesday night, declaring that “bringing inflation down to the Fed’s 2% objective will require tighter policy.”
Others are taking a wait-and-see, alternative scenarios approach, but say they’re prepared to tighten if a more unfavorable inflation scenario plays out.
San Francisco Fed President Mary Daly adopted a relatively neutral approach Wednesday, cautioning that there is “a lot of information” to come before the FOMC has to make a rate decision at its Sept. 15-16 meeting.
This week’s Fed official commentary came on the heels of comments last Friday from three Federal Reserve Bank presidents who voted against the FOMC’s July 29 decision to keep the funds rate in a 3.5% to 3.75% target range.
The three Fed presidents – Minneapolis’s Kashkari plus Cleveland’s Beth Hammack and Dallas’s Lorie Logan — dissented because they “preferred to raise the target range for the federal funds rate by 1/4 percentage point at this meeting” according to the FOMC.
In separate statements, the three contended the FOMC needed to take more urgent action to return inflation to the Fed’s 2% target, given that the economy and labor markets are “solid” enough to withstand some monetary tightening.
By raising rates modestly now, the FOMC could avoid the potential need to tighten more aggressively down the road, Logan and Kashkari wrote.
In a succinct policy statement the FOMC acknowledged that “inflation remains elevated relative to the Committee’s 2% goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy.” It again declared that the Fed “will deliver price stability.”
Talking about the decision in his second post-FOMC press conference, Warsh downplayed the three dissents as nothing but “a good family fight.” He denied the FOMC’s inaction signified any kind of “inertia.” Nor is the FOMC in “a pause,” as one reporter alleged, he asserted.
Rather, “I would characterize what we did as a rigorous review of the economic situation,” he said. “I would characterize what we did as a review of the big, hard questions, and I’d characterize it as a view of what our own homework is, to try to resolve those questions and the period ahead.”
Warsh, who took office May 22, claimed the bond market had accepted the FOMC’s vow to “deliver” price stability by driving up yields, thereby helping the Fed accomplish that goal. “Financial market prices, in this intervening period, they didn’t pause. They reacted to the inflation data in one direction, strong economic growth in the other direction, and nominal and real rates went up.”
The Fed chief implied that the FOMC won’t hesitate to raise rates if inflation trends don’t improve soon. “Did the Fed take an explicit change in its policy rate today? No, but I think that’s the beginning of the story, not the end of the story.“
Comments from other Fed officials this week suggested, on balance, that Warsh would have little trouble mustering a majority for tightening monetary policy – provided inflation risks remain to the upside in the context of strong economic growth and low unemployment.
Leading off Monday, Williams expressed hope that “underlying disinflationary trends (will) continue” and, as he has many time before, said, “Monetary policy currently is well positioned in where we are today to support that disinflationary path.”
However, he warned, “]f the economy is not on a trajectory that will bring inflation back down to 2% . . . . It would absolutely be appropriate to act to get us on a trajectory that does bring inflation back to 2%.”
The FOMC vice chairman, known for expressing a mainstream perspective most of the time, said the FOMC is “laser focused” on lowering inflation to 2%.
Gov. Cook said Wednesday that she did not think it “appropriate” to raise rates last week because of uncertainty about tariff, energy and AI inflationary forces, but suggested it would not take much for her to vote for higher rates.
“Inflation is too high, and I consider the risks to the inflation side of the dual mandate higher than the risks to the employment side at this point,” she said. “As such, I am prepared to act by raising rates, if necessary.”
Noting that “labor market and output growth are currently stable.” Cook told an Anchorage, Alaska Economic Development Corporation luncheon she “would consider how a rate increase could negatively affect that stability.”
But she said she “still … would support an increase, if it becomes necessary to bring inflation down.”
“It may not,” Cook continued. “Some disinflationary forces are already in play, which could push inflation toward our target without a rate increase.” For example, she said tariff effects are “mostly behind us.” What’s more, there is hope that energy costs will decline and provide “some deflationary relief.”
Finally, she said she believes some of the demand pressures on goods prices stemming from AI investment “will ease.”
But Cook, whom President Trump has been trying to fire, emphasized that “uncertainty remains high” about these “disinflationary forces,” which is why she said she was willing to stand pat last week.
But, she declared, “If I do not see signs of continued disinflation soon, I am prepared to act. With five years of above-target inflation, the risk grows that higher inflation may become entrenched in price- and wage-setting behavior, leading to persistence that would be much harder for us to attack.”
“The longer inflation is above target, the more likely this scenario becomes,” she went on. “Thus, while we might be able to afford to wait for longer in a different environment, we do not have that luxury in this one.”
Paulson, another 2026 voter, offered “two plausible scenarios” Tuesday, one in which “too high” inflation recedes, another in which it persists. But she seemed to put more emphasis on the latter.
Inflation could moderate, but “if instead underlying inflation remains stubbornly elevated, the passage of time without progress would itself signal that more restrictive policy is needed,” she said in an essay released by the Philadelphia Fed titled “Keeping an Open Mind.”
Paulson wrote that she “supported” the FOMC’s decision to stay on hold and welcomed the “recent improvement in some inflation data” as “somewhat encouraging” and “a step in the right direction.” But she added, “it is only one step” and said she needs to “more information” to confirm that favorable trends continue.
On a hopeful note, she said, “the brief period of Middle East stability demonstrated that supply shocks can be temporary, reinforcing the case for looking through such disruptions when setting monetary policy.” And she observed that inflation expectations “remain well-anchored.”
But even allowing for energy and tariff-related price increases, Paulson estimated that “underlying inflation” is running “somewhere between 2.4 and 2.8%” and “has been elevated for a long time.”
This long period of above-target inflation is “what I am most focused,” she added, after suggesting the labor market is a non-issue for the FOMC.
Paulson identified two contrary monetary policy scenarios.
“One possibility is that the current setting of the federal funds rate is mildly restrictive and this will bring inflation to 2% in an acceptable time frame,” she said.
“The other possibility, however, is that current policy is not restrictive enough to deliver our target rate of 2% inflation.”
“The most compelling evidence for this view is straightforward: Inflation has been above target for more than five years and even stripping out temporary factors, measures of underlying inflation have edged down only modestly over the past year or so,” Paulson continued. “Persistently elevated inflation suggests more restrictive policy may be needed.”
She said she is “keeping an open mind about where policy goes from here” and said she will “assess” the appropriate policy path “by watching how the evidence accumulates.”
“If policy is appropriately calibrated, I would expect to see growing signs that inflation is coming down – more months of improving inflation data; reports from those making pricing and hiring decisions that align with a gradual return to 2%; signs that pressures from tariffs, energy, and AI are contained rather than intensifying; and inflation expectations that are well-anchored and consistent with 2%,” she said.
“If instead underlying inflation remains stubbornly elevated, the passage of time without progress would itself signal that more restrictive policy is needed,” Paulson concluded.
Some non-voting Fed presidents have also indicated varying degrees of willingness to tighten.
Schmid was even more outspokenly hawkish than Paulson Tuesday evening, flatly asserting, “I believe that bringing inflation down to the Fed’s 2% objective will require tighter policy.”
With the labor market “in balance” and the economy “performing well,” he told as Kansas City Fed agriculture summit audience, “inflation is my primary concern.”
Schmid conceded June price indices showed improvement, but was distrustful. “Inflation has been too high for too long. Though the most recent inflation data for June showed an encouraging deceleration, it would be premature to put too much weight on a single data point relative to recent trends…”
“Our inflation problem is not only about energy,” he said. “Measures of inflation that exclude energy are still running solidly above 2%, revealing an underlying trend in the data. This trend has not been our friend.”
Schmid said “inflation above target implies that there is an imbalance” between supply and demand and said it is the Fed’s job to curb demand even if “supply shocks” may contribute to price pressure.
“A focus on supply shocks often represents an implicit assumption that the factors pushing up inflation are temporary or transitory,” he said, but, “I am uncomfortable ever assuming that a burst of inflation will be temporary.”
So Schmid came down squarely in favor of rate hikes: “ Given the strength of demand and investment, I do not see the current stance of monetary policy as restrictive. As such, I believe that bringing inflation down to the Fed’s 2 percent objective will require tighter policy.”
Daly is not usually considered to be particularly“dovish,” but she sounded far less eager to tighten Wednesday night.
She said she was “completely supportive” of the FOMC’s decision to hold the funds rate steady,
What’s more, she gave no indication she is leaning in one direction or another with the mid-September meeting still five weeks off.
“We have a lot of information we need to collect” before the September 15-18 FOMC meeting to properly assess whether or not inflation accelerated primarily due to passing “supply shocks” or whether more worrisome, underlying forces are at work, Daly said at the Economic and Social Research Institute (ESRI) International Conference in Tokyo.
“There are good reasons to believe inflation will receded as tariff and energy shocks wane, she said, but added that Fed policymakers need to be “vigilant to watch the information as it comes in” and to “be very prepared to take action” if disinflation doesn’t resume.
Musalem indicated he would like to tighten monetary policy as soon as possible in a Thursday evening speech in Sao Paulo, Brazil as he came down heavily on the side of fighting inflation and warned against relying on hoped-for productivity growth to curb inflation.
Given the “resilient” economy and the “stabilized” labor market, and given inflation “well above” the 2% target, he said “the balance of risks is tilted toward inflation remaining above target a year or more from now.”
“Against this backdrop, it is crucial that monetary policy put a meaningful restraint on underlying inflation, rather than tolerating somewhat higher inflation today to pursue productivity growth tomorrow,” Musalem said.
Warsh is well-known for extolling the idea that faster productivity growth can be anti-inflationary and that, therefore, interest rates should be low enough to incentivize productvity-increasing capital investment.
But, without directly mentioning Warsh, Musalem disputed that contention, warning that too easy monetary policy can instead have adverse effects.
“In my view, setting monetary policy easier than conditions would otherwise warrant in pursuit of higher growth would be a mistake,” he told the Brazilian Center for Public Policy Debate. “The size of the eventual productivity gains is highly uncertain, and the argument in favor of easier policy takes for granted the credibility of monetary policy.”
Citing the Warshian hypothesis, Musalem mused, “Perhaps, then, the prize of even slightly faster growth is worth running some inflation risk to claim it.”
But he added, “The trouble is that this reasoning takes the central bank’s credibility for granted. The bargain only works because households, firms and investors keep expecting inflation to return to target.”
Low inflation expectations are “what keeps borrowing costs, wage demands and prices anchored, Musalem elaborated.
But he warned, “A central bank seen to tolerate above-target inflation on the promise of a future productivity windfall can put that anchor at risk. Credibility, once lost, is expensive to rebuild.”