– Probably Need to Hike by 50 BP at Some Point; Shouldn’t Be Off the Table
– Upside Inflation Risks Outweigh Downside Growth Risks From Ukraine War
– Must Be Willing to Adjust Policy; Go Slower on Rate Hikes If Inflation Moderates
By Steven K. Beckner
(MaceNews) – Cleveland Federal Reserve Bank President Loretta Mester Tuesday advocated “front loading” federal funds rate hikes and getting that key short-term interest rate to 2.5% by the end of this year, with more to come next year.
Mester, a voting member of the Fed’s policy making Federal Open Market Committee this year, said the strength of the economy and the tightness of labor markets allows for and necessitates vigorous monetary tightening to bring down 40-year high inflation, despite increased uncertainty arising from Russia’s invasion of Ukraine.
She said the FOMC may well need to raise the funds rate by 50 basis point at at least one of its six remaining meetings this year.
However, like Fed Chairman Jerome Powell, she allowed for policy shifts depending on how the economy evolves, in comments at an event hosted by John Carroll University.
Mester said she “will stay attuned” to how the Ukraine war and other developments affect growth, jobs and inflation and be prepared to adjust monetary policy as needed.
If inflation fails to moderate by mid year, she said the FOMC should raise rates more aggressively, but if inflation slows, she said the pace of rate hikes should do likewise.
For now, she said upside inflation risks outweigh downside economic risks.
Mester joined the FOMC majority last Wednesday in voting to raise the federal funds rate 25 basis points after it had been held near zero for two years. The FOMC said it “anticipates that ongoing increases in the target range will be appropriate.” Participants projected the funds rate will rise to 1.9% by the end of 2022 and to 2.8% by the end of 2023 – above the FOMC’s downwardly revised 2.4% “longer run” or “neutral rate.”
Mester’s fellow voter James Bullard, president of the St. Louis Fed, dissented in favor of an immediate 50 basis point hike. Others have called for more gradual tightening.
The FOMC also decided to start reversing the bond buying it did over the last two years to hold down long-term interest rates, announcing it “expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming *meeting.” Powell said balance sheet reduction could begin as soon as the FOMC’s next meeting May 3-4.
Since the meeting, Powell has made comments widely interpreted as “hawkish,” saying the FOMC will “move more aggressively” if deemed “appropriate.”
However, he also left room for a less aggressive monetary policy approach, emphasizing Monday that the Fed wants to restore price stability without hurting employment and saying flexibility will be required given intensified uncertainty in wake of Russia’s invasion of Ukraine.
“As the outlook evolves, we will adjust policy as needed in order to ensure a return to price stability with a strong job market …,” Powell told the National Association for Business Economics.
For her part, Mester steered a fairly aggressive course as she spoke about combating inflation amid increased geopolitical uncertainty. Although did not join Bullard in seeking a 50 basis point rate hike last week, she made clear she thinks one will be needed at some point this year.
Mester revealed she was among the more aggressive in making rate hike projections. “Based on my current outlook and my assessment of the risks to the outlook, I believe it will be appropriate this year to move the target range of the fed funds rate up to its longer-run level, which I estimate to be about 2.5%, and to follow with further rate increases next year,” she said in prepared remarks.
Asked whether she thinks the FOMC needs to raise the funds rate by 50 basis points at a subsequent meeting, she replied, “I don’t think that should be off the table.”
In fact, since she is calling for a 2.5% funds rate by year’s end, she said “we’re probably going to move at some of those meetings by 50.”
Mester said the FOMC is weighing different risk scenarios as it maps out its monetary strategy, and she said the FOMC is “always willing to adjust appropriate policy to what’s actually happening in the economy” and “be nimble.”
But as things now stand, Mester thinks the focus must be on fighting inflation, which hit 7.9% year over year in February, as measured by the consumer price index.
“Events are unfolding, and uncertainty about the economic outlook over the medium run has risen,” “Despite the uncertainty, I believe it is appropriate that the FOMC take action to get inflation under control and put it on a downward trajectory toward our longer-run goal of 2% while sustaining the economic expansion and healthy labor markets.”
Mester said she expects inflation will “begin to move down later this year and next, but it will take some time and inflation will remain above our goal of 2%.”
She was hopeful that “at some point, the current adjustments underway to increase the resilience of supply chains will help to ease the disruptions, and energy prices will stop increasing, even if they remain somewhat elevated compared to before Russia invaded Ukraine.”
While monetary policy can’t affect those forces, she said “it is an important contributor to the downward trajectory of inflation in my forecast because reducing the level of monetary policy accommodation will help to better align demand with constrained supply, thereby alleviating price pressures.”
“Absent such action, with inflation already at very high levels and demand outstripping supply, there are rising risks that too-high inflation will become embedded in the economy and persist,” she warned.
Mester said she and her fellow policymakers are determined to prevent that from happening.
Ordinarily, she said it would be appropriate for monetary policy to “look through supply shocks that temporarily raise inflation above target.” However, “in the current environment, it seems too risky to allow the high inflation readings to persist and just wait until the supply-side factors putting upward pressure on prices abate.”
“From a risk-management perspective, the Fed needs to take action to reduce excess demand and bring demand into better balance with constrained supply in order to better anchor inflation expectations and put inflation on a downward path to our longer-run goal of 2%,” she said.
The Fed doesn’t need to kill demand, just “push down on the excess of demand,” she said.
“Inflation is very elevated and labor markets are tight by many metrics, yet monetary policy remains at emergency levels of accommodation needed earlier in the pandemic,” she elaborated. “We need to bring monetary policy into sync with the current state of the economy.”
Even after last week’s rate hike, policy is “still accommodative,” she noted.
Mester said the FOMC’s intent is “to remove accommodation at the pace necessary to bring inflation under control while sustaining the expansion in economic activity and healthy labor markets.”
“Because longer-run inflation expectations are still anchored, and there is strong underlying growth momentum in both product and labor markets, I am optimistic we can achieve this by reducing excess demand via our policy actions,” she added.
While raising the funds rate, Mester said the Fed will also be reducing its $9 trillion balance sheet sooner and faster than when it was last doing so.
“We will do that in a predictable manner primarily by adjusting the reinvestment amounts of the principal payments we receive on our assets,” she said. “Other details of the plan for reductions are being finalized.”
“The plan will draw on our experience during 2017 to 2019 when we reduced our balance-sheet assets, which had grown in the wake of the Great Recession,” she continued. “But the balance sheet is much larger, in terms of both the dollar value of assets and assets relative to GDP, and inflation is much higher than it was then. So it is appropriate to start reducing the balance sheet sooner and proceed at a faster pace this time.”
Mester said “one benefit of this plan is that we will be removing the downward pressure our holdings put on yields at the long end of the yield curve while we are raising rates at the short end, thereby reducing monetary policy’s distortionary effects on the shape of the yield curve as normalization proceeds.”
“We’re still working on the details,” she told the audience.
Responding to a question about the largely positive reaction of financial markets to the FOMC’s decision to start raising rates and reduce the balance sheet,” Mester said, “financial markets are astute. Inflation is at a 40-year high. They know that is not a good sign for sustainable expansion … They are supportive of the Fed wanting to get inflation under control.”
Like Powell, she allowed for a different policy course. “Of course, the ultimate pace at which monetary policy accommodation is removed will need to be data driven and forward looking.”