– To Reduce Inflation Rates Must Rise ‘Pretty Rapidly,’ Stay ‘Higher For Longer’
– Slower Growth Raises Recession Risk In Event Of Shock; Might Require Adjustment
– Once Appropriate Rate Level Reached Can Move To ‘Ordinary,” Data-Dependent Policy
By Steven K. Beckner
(MaceNews) – Were some “shock” to tip the U.S. economy into recession, the Federal Reserve might have to reconsider its monetary policy stance, but for now the “very strong” U.S. labor market gives the Fed “room to maneuver” as it tries to reduce inflation through more restrictive policy, St. Louis Federal Reserve Bank President James Bullard said Thursday.
Given that there is “quite a bit of inflation” together with labor market strength, Bullard said he and his fellow policymakers can and should raise interest rates “pretty rapidly.” If inflation persists, rates will have to stay “higher for longer,” he said.
He pointed to the fact that initial jobless claims fell to a five-month low of 193,000 last week as proof of how “extremely strong” the labor market is.
Bullard, a voting member of the Fed’s policymaking Federal Open Market Committee, acknowledged slower growth has increased the risk of recession if there is a “shock,” but said the Fed is not trying to “engineer a recession” to return inflation to the Fed’s 2% target as he spoke to reporters following an HSBC-sponsored Global Emerging Markets Forum.
He maintained that the key to reducing inflation is restraining inflation expectations and preserving the Fed’s anti-inflationary “credibility,” not driving up unemployment as adherents of the “Phillips Curve” trade-off between unemployment and inflation often contend.
Bullard joined his fellow FOMC members in approving a 75 basis point hike in the federal funds rate last Wednesday. It was the third straight move of that size and took the funds rate to a target range of 3 to 3.25% and was accompanied by a dramatic upward revision of rate projections. In their revised Summary of Economic Projections, FOMC participants envisioned the funds rate rising to a median 4.4% by the end of this year and to 4.6% by the end of 2023 – sharply higher than in the June SEP.
Powell told reporters, “we need to bring the federal funds rate to a restrictive level and keep it there for some time.” He vowed to move to a restrictive stance “quickly” and to “keep at it until we’re confident the job is done.”
Bullard’s latest comments were consistent with the Fed chief’s message. At the Sept. 21-22 meeting, he said, “the judgment was that we had to do more to get inflation under control,” and he said financial markets correctly interpreted the FOMC’s message and its upwardly revised rate projections.
Since the FOMC meeting, a host of Fed officials have exhibited a high degree of consensus on reducing inflation, but participants’ median funds rate projection of 4.6% next year is predicated on what some regard as optimistic forecasts – GDP growth of 1.2%; unemployment rising to just 4.4% and inflation receding to 2.8%.
If GDP weakens more than expected or if unemployment rises more than expected, but inflation remains higher than expected, Bullard was asked by Mace News whether the FOMC would remain strongly committed to keeping monetary policy restrictive “until the job is done,” or whether it would have to recalibrate and adjust policy even if inflation remains high.
Bullard responded by suggesting the Fed is unlikely to find itself in a position where it has to abandon or ameliorate its anti-inflation campaign and by saying that if high inflation persists, the strong labor market would give the FOMC leeway to maintain, if not, further boost interest rates.
“On the labor market, I think we have some room to maneuver, because unemployment is at 3.7%, and I don’t think many people think that is the natural rate of unemployment for the U.S.,:, he said. “So now if we go to 4 1/4 or 4 ½%, or even higher than that, that would be still consistent with a very strong labor market and consistent with U.S. labor market performance historically.”
“So right now we have sort of a labor market that is unusually strong and we could go to a labor market that is just kind of normally strong, and in that sense I think we have room to maneuver,” he continued. “So, I think we can be very credible in saying that if we get bad news on inflation and it does not decline, then that means (rates) need to be higher for longer in order to get downward pressure on inflation and get the economy back to a balanced growth path.”
Bullard went on to take issue with the premise that the Fed must weaken the economy to control inflation and that it would have to halt its efforts to curb inflation if unemployment rises.
“I would also say this about the whole discussion around this issue in the press and in the policy circles I travel in,” he said. ‘The reason you want to get rid of the inflation is you get a better equilibrium. You get maybe somewhat less consumption today than you would otherwise have, but more consumption tomorrow than you would otherwise have and a better equilibrium for the whole economy. So, you’re kind of smoothing things out in a way that gets inflation back to target.”
“I think that if you just emphasize the part that consumption would be less than otherwise, then you‘re not getting the other part of the story – that you’re getting to a better equilibrium with higher consumption tomorrow than what you would otherwise have,” he elaborated. “So, the higher interest rates are pushing some consumption that you would have today off into the future and encouraging saving today for that future….”
Bullard said “that joint combination of the current situation and the future situation is better than if you just continually tried to get more consumption today all the time. Then you get into a 70s type of outcome where you have lots of problems. So it really is better policy.”
Because then Fed Chairman Paul Volcker restored the Fed’s credibility in the late 1970s and early 1980s, the current Fed “has a better chance of success” in restoring price stability without undue economic pain, Bullard said.
While saying the Fed has “room to maneuver” thanks to labor market strength, Bullard allowed for a potential policy shift if the economy were to go into recession.
He acknowledged that the risk of recession has increased because of slower growth, likening the Fed to a tight rope walker who could be thrown off balance by a gust of wind.
Were there to be a shock of some kind that triggered a recession, “we would have to make policy appropriately for that,” he conceded, adding, “that’s not what we’re tying to engineer.”
Bullard, who foresaw the funds rate needing to go to 3 ½% in the Spring, said that now a 4 ½% funds rate is needed because inflation has been higher than expected.
Even taking out the most extreme price changes, as the Dallas Fed does with its “trimmed mean” price index, inflation is running 4.4% from a year ago – more than double the Fed’s 2% target, he noted.
Therefore, he said, the FOMC must raise rates “pretty rapidly to get to a minimally appropriate level to handle inflation.”
He expressed the hope to forum participants that by “get(ting) policy positioned to get inflation down in an as expedient a way as we can…we’ll be able to get inflation down now as opposed to 1970s.when inflation lingered for 15 years or so…”
The FOMC must get inflation down to 2% “in a reasonably compact time frame” to establish its credibility, he said.
To the extent that high inflation lingers this time, he repeated that rates will need to stay “higher for longer.”
Bullard, who was among the first to argue for swifter action to reduce inflation, rejected arguments that, after waiting too long to tighten monetary policy, the Fed is now “overdoing” it. But he envisioned a time when the Fed can take a less aggressive approach.
“My goal has been to get the policy rate to a level that is reasonable for this environment,” he said. ‘We started at near zero, which was not reasonable,” he explained. “We have had to move a lot in a short period of time” to “get to a level that makes sense…”
Once that “sensible” level is reached, he said, “at that point you can argue we can get back to a more ordinary monetary policy” where the FOMC would be “taking account of recent data, making adjustments or standing pat depending on how data comes in,” he went on, while making clear that point is still some ways off.
As for the market-shaking events in Europe and the UK, Bullard said the Fed keeps close tabs on international developments, but made clear U.S. monetary policy will remain domestically oriented.
Regarding the Fed’s balance sheet reduction, which began later than he would have liked, Bullard said that policy “is helping us,” but said he didn’t know how much. He said he would not want to consider any changes to the policy for at least six months.