– Fed Should Look for Place to ‘Rest’ in Raising Rates
By Steven K. Beckner
(MaceNews) – Chicago Federal Reserve Bank President said Monday that the Fed needs to keep making monetary policy more “restrictive,” but warned against “overdoing” its interest rate increases and suggested it should look for a place to “rest” or pause to reassess the effect of its monetary tightening.
Evans, speaking to the annual meeting of the National Association for Business Economics (NABE), was hopeful that the Fed can still achieve a “soft landing” – a reduction of inflation without a recession.
Evans, who will be voting on the Fed’s policymaking Federal Open Market Committee next year, was one of the last Fed officials to give up on the idea that high inflation was “transitory,” and that monetary policy was not too loose, but he told the NABE he is now fully on board with the FOMC’s campaign to reduce inflation to its 2% target.
Evans suggested, however, that there are limits to how far he’s prepared to go in fighting inflation.
“(T) principal issue facing the economy in the U.S. and elsewhere around the world (is) inflation,” he said, adding, “reducing inflation to a level consistent with the Fed’s 2% objective will require a period of restrictive financial conditions to restore better balance between supply and demand economy-wide.”
“This will generate below-trend growth and some softening of labor market conditions….,” he conceded.
At its Sept. 21- 22 meeting, the FOMC voted unanimously to raise the federal funds rate another 75 basis points to a target range of 3 to 3.25% – culminating 300 basis points of monetary tightening since the FOMC stopped holding the funds rate near zero in March. In their revised quarterly Summary of Economic Projections, FOMC participants projected the funds rate rising further to a median 4.4% at the end of 2022 and to 4.6% at the end of 2023.
Citing those projections, Evans observed, “most FOMC participants are looking at something like another 100 to 125 basis points of rate increases this calendar year, with the median projection for the federal funds rate then rising a bit further to 4.6 percent at the end of next year….”
He said reducing inflation will “require reducing the heat in labor and product markets
as well as maintaining a downward pull from inflation expectations. This is where tighter
monetary policy comes into play.”
“I see the nominal funds rate rising to a bit above 4-1/2 percent early next year and then remaining at this level for some time while we assess how our policy adjustments are affecting the economy,” he continued. “When you factor in inflation expectations and the reductions in our balance sheet, we’ll be at something equivalent to nearly a 2% real funds rate at this time.”
Evans said “this is a fair amount of restriction when compared with the 1/4 to 1/2 percent long-run real neutral federal funds rate that is implied in the SEP. But I feel it is needed to facilitate market adjustments by bringing aggregate demand into better balance with aggregate supply and to ensure that long-run inflation expectations remain in check …..”
However, Evans went on to caution against being overly aggressive in raising rates.
“Front-loading was a good thing, given how far below neutral rates were,” he said. “But
overshooting is costly, too, and there is great uncertainty about how restrictive policy
must actually become.”
Elaborating on his prepared remarks, Evans told reporters that March might be an appropriate time for the FOMC to “rest” after getting the funds rate into a 4 ½ to 4 ¾% range to avoid “overshooting.”
However, if high inflation were to persist and/or if infllation expectations were to rise, he said the funds rate might have to go higher than now projected.
Evans was optimistic that won’t happen and cited factors in play that he currently thinks should limit the need for monetary restraint.
Explaining why he thinks the Fed can pause tightening in March, Evans cited two considerations.
“One is, yes, we’re facing high inflation rates, but some of that is supply-chain driven, so I’m expecting that to ease somewhat,” he said. “That will reduce the amount of inflation that we need to be bringing down.”
“As I look at the inflation that is more amenable to responding to more restrictive monetary policy where demand will be reined in somewhat to be in line with supply that’s a smaller part of the inflation improvement, but it’s meaningful.”
“Second, when we get to this …. 4 1/2 to 4 ¾% nominal rate, I think inflation coming down will make this ultimately consistent with about a 1 ½% real rate,” he continued. ‘That is historically almost sort of the upper range of when the Fed has had restrictive monetary policy in order to rein in inflation. So I think it’s historically in line with that.”
“In additon to that we’re going to have assets rolling off our balance sheet, and it’s reasonable, though there’s great uncertainty over this, that might be worth 35 to 50 basis points,” he went on. “So that would take it up to the 2% real interest rate, which I think would be at the upper end of sort a normal type of response to inflation.”
Evans said that reaching a 2% real rate is “a good way to judge how high you have to go” and cautioned against going beyond that into greater monetary restraint.
“I worry that if the way you judge it is, ‘Oh another bad inflation report, it must mean we need more (rate hikes),’ because we could get a few of those, and if we’ve already done so much with front-loading then that sort of puts us at somewhat greater risk of responding overly aggressively.”
“And even though you could perhaps take that back before too long if you realized it was overshooting, sort of perceiving that to be the case takes longer than that, and I’m not sure it’s as easy or costless as that either,” he continued.
Once the FOMC gets “to a point where you think you can sort of be sufficiently restrictive (and) explain it to everybody…,” Evans said “that would put you in about the right place to go forward and monitor data.”
Again warning against too much tightening, Evans said, “Even an increase in unemployment rate from where we are now at 3 ½ to 4 ½% represents a substantial loss of employment for a number of people, and that by itself is painful ….”
Besides, he said he is “optimistic that the current inflation issues have a substantial component that is supply-driven increase in inflation and that as that beings to improve that’s going to reduce inflationary pressures and in fact could even lead to some round-tripping fo some prices…”
Evans, referring to the FOMC’s September SEP rate projections said, “we’re headed toward this 4 1/2-ish fed funds rate by March. If you look at those dots, I don’t think anybody is looking for that last rate increase to be in December…”
“One way or another we have made the judgment that we’re going to put a lot of restrictiveness in place no matter how the data come in at,” he said. “Unless there’s a lot in the next two months, there’s just not enough time for that (doing more).**
The FOMC should pause its rate hikes in March, according to Evans, expressing the view that “given where I see inflationary pressures, given where I see the state of demand, that this 41/2 to 4 3//4% funds rate is a place to rest.”
“There’s good reason to believe that that’s where this 2% real interest rate (lies) – and 2% is on the high side of what monetary policy responses have been – and so I think there’s a very good argument for that,” he said.
Pointing to “supply improvements” in shelter and other areas and to slower increases in wages, Evans said, “there’s a lot of reasons to see things in the works in line with our forecast.”
He did allow for upside surprises that could force the Fed to tighten more, though. “I think that data that clearly rock the forecast – to think, ugh, there’s other fundamentals that are going to drive it (inflation) higher — in my mind that would be what’s necessary to take it (the funds rate) to a higher level. But you have to be humble….”
Evans also stressed the importance of containing inflation expectations. “Underlying all this is that it’s important for inflation expectations to be relatively stable…. if we lost inflation expectations and they started to rise that would be a different ball game.”