– Funds Rate Must Become ‘More Restrictive’; Stay So “for a While’
– Risks Of Tightening Too Little Outweigh Risks Of Tightening Too Much
– Welcomes Oct. CPI Report But Warns of ‘Upside Risks,’ Wage Pressures
– Reducing Inflation Will Mean ‘Pain’; Unemployment May Need Rise More Than Anticipated
By Steven K. Beckner
(MaceNews) – Cleveland Federal Reserve Bank President Loretta Mester said Thursday that, despite another sharp increase in the federal funds rate last week, the key overnight money market rate is only starting to become restrictive and said it will need to become more restrictive and stay so “for a while.”
How high the funds rate needs to go and how long it will need to stay there will depend on the behavior of inflation and inflation expectations, she said, but suggested it may have to go significantly higher.
Mester, a voting member of the Fed’s policymaking Federal Open Market Committee, said the risks of tightening monetary policy too little outweigh the risks of doing too much.
Reducing inflation to the Fed’s 2% target will take time and will require “pain,” possibly including higher than expected unemployment, she told Princeton University’s Bendheim Center for Finance,
On a day when the Labor Department announced an unexpectedly large slowing in October inflation, Mester seemed unimpressed. The consumer price index rose 0.4% or 7.7% from a year ago – down from 8.2% in September. The core CPI was up 0.3% or 6.3% on a year-over-year basis.
Mester conceded the report “suggests some easing in overall and core inflation,” but added, “On the other hand, services inflation, which tends to be sticky, has not yet shown signs of slowing. In addition, inflation continues to be broad-based.” She also cited excessive wage increases.
And she warned, “there are upside risks to the inflation forecast.’
“In order for inflation to fall, there will need to be further slowing in product and labor markets, bringing demand into better balance with supply to alleviate price pressures,” she said in prepared remarks.
Mester also cautioned that the Fed “can’t take for granted” inflation expectations being “anchored.” To keep them anchored, she said monetary policy needs to be made “more restrictive.”
Last Wednesday, the reputedly “hawkish” Mester joined in a unanimous FOMC decision to raise the federal funds rate by 75 basis points for a fourth straight meeting and to signal “ongoing increases’ in the Fed’s policy rate.
In announcing the increase, which took to the funds rate to a target range of 3.75% to 4.0%, the FOMC said further rate increases are needed “in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.”
“In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” the FOMC policy statement added.
Chairman Jerome Powell told reporters after the meeting that a slower pace of rate hikes come as soon as next month, but said “it is very premature to be thinking about pausing” because the Fed has “a ways to go” to make monetary policy “sufficiently restrictive” to reduce inflation to the Fed’s 2% target. He also said the funds rate will need to go higher than projected in the FOMC’s September Summary of Economic Projections. The median funds rate projection at that time was 4.4% by the end of this year and 4.6% by the end of 2023.
A new SEP with a revised “dot plot” will be released at the conclusion of the FOMC’s final meeting of the year, Dec. 15-16. It is expected to show higher funds rate projections.
Mester minimized the extent to which the FOMC has made monetary policy restrictive thus far and emphasized the need to get policy to a more restrictive level and keep it there.
Although rates have been raised at “a brisk pace” since March, she said, “compared to history, the economy is experiencing very high and persistent inflation, and the real policy rate is just beginning to move into restrictive territory.”
Echoing the FOMC’s pledge to make monetary policy stance “sufficiently restrictive,” Mester said, “Given the level and persistence of inflation, the journey back to 2% inflation will likely take some time.”
Thus far, the Fed’s focus has been on “how quickly we could get to that restrictive stance,” she said. But “now the focus can shift to the appropriate level of restrictiveness that will return the economy to price stability in a timely way.”
“Given the current level of inflation, its broad-based nature, and its persistence, I believe monetary policy will need to become more restrictive and remain restrictive for a while in order to put inflation on a sustainable downward path to 2%…,” she continued.
Mester left unclear how high she thinks the funds rate will need to go. “Precisely how much higher the fed funds rate will need to go and for how long policy will need to remain restrictive will depend on how much inflation and inflation expectations are moving down, which depends on how much demand is slowing, supply challenges are being resolved, and price pressures are easing,” she said.
“To help me make the assessment of how high and how long, I will be looking at a variety of incoming information and data, including the official statistics, survey evidence, and reports from our business, labor market, and community contacts, which are more forward looking than other data sources,” she added.
Mester warned “the transition back to price stability will take some time and will not be without some pain. It is likely that there will continue to be higher-than-normal levels of financial market volatility, which can be difficult to navigate. With growth likely to be well below trend, it could easily turn negative for a time….”
She said, “it is also possible that the unemployment rate could go up more than anticipated and this would impose difficulties on households and businesses.”
Mester said she and her fellow policymakers “will need to continue to weigh the risks of tightening too much against the risks of tightening too little.”
“Tightening too much would slow the economy more than necessary and entail higher costs than needed,” she said. “Tightening too little would allow high inflation to persist, with short- and long-run consequences, and necessitate a much more costly journey back to price stability….”
Mester weighted the risks on the side of not tightening enough. “Despite the moves we have made so far, given that inflation has consistently proven to be more persistent than expected and there are significant costs of continued high inflation, I currently view the larger risks as coming from tightening too little.”
“As policy moves further into restrictive territory, the effects of our cumulative tightening will work through to the broader economy, and I anticipate that we will see inflation pressures ease,” she went on. “At that point, I expect that my view of the balance of these risks will shift, and I will welcome that shift because it will mean that inflation is moving down in a meaningful way.”
Responding to questions, Mester said the FOMC will “have to be judicious balancing the risks to minimize the pain of the journey.”
Expounding on the inflation outlook in a Q&A session, Mester called the October CPI reading “very good,” but added, “we’re going to have to bring the funds rate up some more to make sure we get that sustainably coming down.
She expressed concern about inflation pressures from the job market.
“There has been a slight moderation in labor market conditions, but the labor market remains tight,” she said, pointing to the “still very low” 3.7% unemployment rate.
Answering questions, Mester said job openings have started to decline, but said labor markets are still too tight and require more monetary efforts to restrain labor demand and labor cost pressures.
“Another indication that labor demand is outpacing labor supply is strong wage growth,” she said. “The year-over-year growth rate of the employment cost index is 5%, well above the level consistent with price stability…”
Mester said she does expect inflation to “begin to slow meaningfully next year and the following year,” but said it won’t reach 2% until 2025. She vowed, “We will be diligent in making that happen, that is, we will proceed with care and conscientiousness.”
She was cautious in interpreting various readings on inflation expectations.
“Near-term expectations have risen significantly with actual inflation, and they have fallen in recent months as gasoline prices have declined,” she noted. “Inflation expectations over the longer term have risen much less. They remain reasonably well anchored at levels consistent with our goal and that should help to lower inflation without as large of a slowdown in activity.”
“However, we cannot take that anchoring for granted,” she went on. “The longer actual inflation and near-term inflation expectations remain elevated, the greater the risk that longer-term inflation expectations become unanchored and high inflation permeates wage- and price-setting behavior and investment decisions, making it much more costly to return inflation to our goal.”
Although the funds rate is the Fed’s primary policy tool, she said balance sheet reduction “is having a good effect on helping inflation come down” and said that to the extent the run-off from the Fed’s bond holdings helps reduce inflation “we might have to do less work with our interest rate tool.”
Earlier, two 2023 FOMC voters expressed somewhat divergent views on monetary policy going forward.
Philadelphia Fed President Patrick Harker said that, after the funds rate gets to 4.5%, he would be “OK with taking a brief pause” to see “how things are moving” before possibly resuming tightening.
Dallas Fed President Lorie Logan, after calling the October CPI report “a welcome relief,” said “there is still a long way to go” and said the Fed needs to stay committed to reducing inflation.
“Sufficient cooling of the economy will eventually bring inflation back to our target,” she said. “But this process is just getting started. The labor market remains very tight, and wages continue to grow considerably faster than the rate that would be consistent with 2% inflation.”
With the Fed raising the funds rate and reducing its bond portfolio, Logan observed that “broad financial conditions have tightened significantly” and said “these tighter financial conditions are beginning to bring demand back into balance with supply, particularly in interest-rate-sensitive sectors such as housing.”
But she suggested the Fed needs to be nimble to keep financial markets working for the Fed. “The FOMC must restore price stability—but must also proceed in a way that allows us to better assess how financial and economic conditions are evolving.”
“While I believe it may soon be appropriate to slow the pace of rate increases so we can better assess how financial and economic conditions are evolving, I also believe a slower pace should not be taken to represent easier policy,” Logan elaborated.
“I don’t see the decision about slowing the pace as being particularly closely related to the incoming data,” she continued. “The restrictiveness of policy comes from the entire policy strategy—not just how fast rates rise, but the level they reach, the time spent at that level, and, importantly, the factors that determine further increases or decreases.”
“The FOMC can and should adjust other elements of policy to deliver appropriately tight conditions even as the pace slows,” she went on. “We must remain firmly committed to our 2% inflation goal.”
Logan said she will be “watching the evolution of the labor market and economy, as well as thinking about real yields and about the accuracy of inflation forecasts, among other factors. Real interest rates remaining significantly above zero would contribute to the slowing of demand that I expect will reduce inflation ….”