– Daly: 2 Rate Hikes ‘A Very Reasonable Projection’; Could Do More or Less
– Mester Urges ‘Somewhat Tighter Monetary Policy’ For ‘More Timely’ Inflation Fall
– Daly: Banks Not Curbing Credit More Than Expected in Slowing Economy
By Steven K. Beckner
(MaceNews) – Senior Federal Reserve officials largely concurred Monday on the need for tighter monetary policy to combat inflation.
San Francisco Federal Reserve Bank President Mary Daly called two more Fed rate hikes a “very reasonable projection,” although she said the Fed’s rate-setting Federal Open Market Committee could end up doing either more or less than that.
Cleveland Fed President Loretta Mester, usually thought of as a more “hawkish” Fed official, argued in favor of a “somewhat tighter monetary policy” to accomplish a “more timely path back to 2% inflation,” warning that delay could entrench higher inflation expectations. She did not specify how much higher she thinks the federal funds rate needs to go.
Significantly, Daly downplayed the potential impact of March bank failures on the availability of bank credit – a sharp contrast to the view that she and other Fed officials once held – that bank lending restraint would substitute for at least one Fed rate hike. She said banks are slowing lending, but no more than one would expect in a slowing economy.
The two non-voting Federal Reserve bank chiefs’ comments come nearly a month after the FOMC left the funds rate unchanged in a target range of 5.0% to 5.25% after raising that key money market rate in 10 straight rate hikes totaling 500 basis points. While leaving the funds rate unchanged on June 14, FOMC participants projected it will climb to a median 5.6% (5.5 to 5.75%) by the end of this year.
Subsequently, Fed Chair Jerome Powell noted that “a strong majority of Committee participants expect that it will be appropriate to raise interest rates two or more times by the end of the year.” He said the Fed has “a long way to go” to achieve its 2% inflation target and said, “it will take time, however, for the full effects of monetary restraint to be realized, especially on inflation.”
The Mester and Daly comments come in wake of a June employment report that showed smaller than expected non-farm payroll gains, but also a drop in unemployment and a pick-up in the growth pace of average hourly earnings.
Pointing to “strong labor market” data, Daly said, “things are getting better in terms of supply and demand (balance) but we’re not there yet.”
So, she said, “we are likely to need a couple more rate hikes this year to bring inflation back into 2% path .… A very reasonable projection is that a couple of more rate hikes will be necessary.”
Daly, speaking in a virtual “fireside chat” sponsored by the Brookings Institution, stipulated two more rate hikes is “a reasonable projection with a great deal of data dependability around it …. We could end up doing less or we could end up doing more.”
Taking note of the employment report, Mester warned that it showed wages are still rising too rapidly to bring inflation down to target.
“Progress is now being made in bringing demand and supply into better balance, but it is slow progress and demand is still outpacing supply,” she told a videoconference hosted by the University of California- San Diego Economics Roundtable, adding that although the monthly pace of job growth has slowed, “it remains robust, with payroll gains averaging more than 240 thousand per month from April to June.”
“The unemployment rate is 3.6%, near its 50-year low, and it has been basically at that level for over a year,” she continued. “The number of job openings has been moving down but the ratio of job openings to the number of unemployed workers is more than 1.6. That is well above the 1.2 level seen in the strong labor market conditions in 2019….”
Mester said “the question is whether the current strength in labor demand relative to supply is consistent with price stability.” She answered in the negative:
“By some measures, wage pressures have moderated, and firms tell us they are not expecting the outsized wage gains of the last couple of years to persist except for those with skills particularly in demand,” she said. “Nonetheless, wages are still growing at an annual rate of about 4-1/2 to 5 percent. This is well above the level consistent with 2 percent inflation given current estimates of trend productivity growth. “
“Indeed, for wage growth at the current pace to be consistent with price stability, trend productivity growth would need to be 2-1/2 to 3 percent, instead of the current estimates of 1 to 1-1/2 percent,” Mester went on. “We have not seen any evidence that trend productivity growth is rising; in fact, productivity has declined over the past year.”
Wage pressures are, in turn, fueling inflation and necessitating more monetary restraint, according to Mester.
She acknowledged “progress is being made on inflation” overall, but added, “Unfortunately, we see less progress with core inflation, which excludes food and energy prices. Core PCE inflation peaked in February 2022 at 5.4 percent. It has moved down a bit since then, but progress has stalled, with core inflation running about 4.6 percent over the past six months….(C)urrently the core measure indicates that inflation is stubbornly high and broad-based….”
Mester said “inflation in both core goods and core services remains high” and noted that “services inflation also tends to be more persistent than goods inflation ….”
“Inflation in core services excluding housing, which accounts for 50% of total consumption, tends to be sticky and correlated with wage inflation and the strength in the labor market,” Mester observed. “Although inflation in this component slowed in May, it has shown little improvement over time.”
Mester said the Fed “will need to see continued sustained disinflation in the prices of goods, housing, and core services excluding housing” to achieve its 2% target and said that will require tighter monetary policy, although she wasn’t specific about how high she thinks the funds rate needs to go.
“The FOMC has come an appreciable way in moving policy from a very accommodative stance to a restrictive one,” she said. “We are closer to the end of our tightening phase than the beginning.”
“Because monetary policy affects the broader economy with a lag, some of the tightening already in place will help to further moderate demand in both product and labor markets, thereby easing price and wage pressures,” Mester continued. “So I do expect inflation to move down further this year, although it will take longer to reach our 2% goal.”
However, she maintained the economy’s “underlying strength” and continued “stubbornly high” inflation require more FOMC rate action.
“In order to ensure that inflation is on a sustainable and timely path back to 2 percent, my view is that the funds rate will need to move up somewhat further from its current level and then hold there for a while as we accumulate more information on how the economy is evolving …,” she said, noting that at the June FOMC meeting, “all but two participants anticipate that further rate increases will be appropriate this year.”
Mester said “risk management considerations” cause her to believe that “policy will need to tighten somewhat further to put inflation on a sustainable and timely path back to 2%.”
“First, while policy is now in restrictive territory, it is less restrictive compared to many historical tightening cycles,” she said. “That partly reflects the fact that when we started tightening in March 2022, policy was very accommodative; so much of the tightening was to move policy to a neutral stance. Until recently, the real policy rate, i.e., the nominal rate adjusted for inflation, has been below −0.5 percent, the median projection among FOMC participants of the long-run real fed funds rate.”
“As inflation falls, the real rate will rise even without further increases in the nominal fed funds rate. Waiting for that passive tightening to happen, though, risks allowing inflation to remain elevated for longer,” she added.
Second, Mester linked persistent inflation and the risk of inflation expectations getting out of control.
“(I)nflation has surprised us on the upside for some time,” Mester said, noting that FOMC participants expect inflation to “remain slightly above 2% at the end of 2025, which is the farthest out the projections go. If so, then inflation will have been above our goal for over 4 years. And that is ignoring the risks that could play out, which most participants see as tilted to the upside for inflation.”
Mester said “a more timely path back to 2% inflation, which would be encouraged by somewhat tighter monetary policy, is desirable because the longer inflation remains elevated, the higher the risk that inflation expectations could become unanchored from our 2 percent goal….”
Both Fed presidents addressed the risk of tightening too tight versus tightening too little.
Daly said she sees the risks as “more balanced” after 500 basis points of Fed tightening. “The risks of doing too little still outweigh the risks of doing too much, but (the gap) is more narrow .…”
Because of this, she said the FOMC has been justified to “turn back on the dial of” monetary tightening to give the Committee “more time to assess the economy.”
Mester argued that “a somewhat tighter policy stance will help achieve a better balance between 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 to get inflation back to our goal. 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 said ‘a slightly higher policy rate would roughly equate the probabilities that the next policy move will be a tightening move versus a loosening move. This would be a good holding point as we accumulate more information about whether the economy is evolving as expected. If it is not, then we can adjust our policy rate either up or down, as appropriate….”
At the March and May FOMC meetings, Fed policymakers were of the belief that stresses in the banking system would tighten bank credit availability in a way that would supplement tighter monetary policy, or even substitute for it. Daly, whose Bank played a central supervisory role in the problems with Silicon Valley Bank and others, shared that view, but now she takes a different one.
“Back in March. I actually was thinking (bank) credit tightening …. could end up with maybe a 25-50 equivalent rate hike,” she said, “but at this point it seems to be less than that … It’s not really different than what you’d expect given the slowing of the economy.”
Based on survey findings and other information showing slower loan growth and tighter lending standards, Daly said that banks are looking at their balance sheets and interest rate risks and are acting “exactly how you’d want them to behave.”
She said smaller banks may be restricting credit more than larger ones, however.