By Steven K. Beckner
(MaceNews) – Expressing heightened concern about inflation, Cleveland Federal Reserve Bank President Loretta Mester called Wednesday for an early and relatively rapid firming of monetary policy.
Mester, a voting member of the Fed’s policy making Federal Open Market Committee this year, said she favors starting to raise the federal funds in March and said the FOMC should also start reducing the size of the Fed’s $8.8 trillion balance sheet “soon.”
Both actions should occur sooner and faster than the last time the Fed was withdrawing monetary stimulus, she told the London-based European Economics and Financial Centre.
Even with the upward revisions which she and her FOMC colleagues made in their December Summary of Economic Projections, inflation risks are “to the upside,” Mester said in prepared remarks. She said “imbalances” between supply and demand are fueling both price and wage increases.
She expressed hope that inflation will moderate from its recent 7% pace, but if it doesn’t she said she would favor a more rapid pace of rate hikes in the second half.
Mester joined a unanimous FOMC vote Jan. 26 to state that it “will soon be appropriate” to raise the federal funds rate from the zero to 25 basis point target range it’s been in for the last two years and to end asset purchases by early March.
The statement, predicated on the FOMC’s judgment that it had fulfilled its “maximum employment” objective, was seen as a strong signal that “liftoff” will occur at the March 15-16, and Chairman Jerome Powell reinforced that message in his post-FOMC press conference.
The FOMC also released a broad set of “Principles for Reducing the Size of the Federal Reserve’s Balance Sheet” in preparation for slimming the Fed’s bloated portfolio of bond holdings accumulated over two years of “quantitative easing.” Powell said the FOMC would announce a more detailed strategy for “substantially” reducing the $8.8 trillion balance sheet after another “couple” meetings.
In their last SEP in December, FOMC participants projected three funds rate hikes this year, but markets are expecting more than that and are also anticipating the start of “quantitative tightening” around mid-year.
Mester seemed to suggest that a greater number of rate hikes, along with aggressive QT may be necessary to bring wage-price pressures under control.
“Just as demand and supply need rebalancing, so does monetary policy,” she said. “Inflation has been running well above our 2 percent goal for some time, labor markets are very strong, and solid momentum in underlying demand is expected to continue.”
“So the extraordinarily accommodative monetary policy that was needed earlier in the pandemic is no longer appropriate,” she continued. “While monetary policy cannot alleviate the constraints on supply, it can help to moderate demand by making broader financial conditions less accommodative, thereby reducing inflationary pressures.”
Mester said “it is clear that removing the extraordinary monetary policy accommodation is needed to help rebalance the economy.” Rates are too low and asset purchases “are no longer needed.”
So she said that “barring an unexpected turn in the economy, I support beginning to remove accommodation by moving the funds rate up in March.”
When the FOMC last left the zero lower bound for the funds rate, it did so very gradually and incrementally. But Mester said that “ttis time, I anticipate that it will be appropriate to move the funds rate up at a faster pace because inflation is considerably higher and labor markets are much tighter than in 2015.”
“In my view, increases in the fed funds rate in the coming months will be needed, but the ultimate path of the fed funds rate in terms of the number and pace of increases will depend on how the economy evolves,” she elaborated.
“For example, if by mid-year, I assess that inflation is not going to moderate as expected, then I would support removing accommodation at a faster pace over the second half of the year,” she continued. “On the other hand, if inflation moves down faster than expected, then the pace of removal could be slower in the second half of the year than in the first half.”
As for balance sheet policy, Mester again recalled that after the Fed began reducing its balance sheet in 2017, it did so belatedly and gradualy, but said “ The reductions lasted until August 2019. While this experience will inform our plans, this time, things are different.”
“First, the balance sheet is about double the size it was then, and even in our ample-reserves operating regime, it is considerably larger than the size needed to implement monetary policy efficiently and effectively,” she observed. “Second, inflation is much higher and labor markets are much tighter than they were then.”
“So in my view, conditions warrant that we start balance-sheet reductions soon and go at a faster pace than we did last time,” she added.
Mester said the timing of a halt to balance sheet reduction “will depend on the banking sector’s demand for reserves, as well as the distribution of that demand across institutions, which will evolve over time.”
Mester said she would also favor a disproportionate reduction in Fed holdings of agency mortgage backed securities.
“Today, as a result of our purchases, about a third of our portfolio, over $2.5 trillion, comprises agency securities,” she said. “While our principles state that we will reduce balance-sheet assets primarily by adjusting the reinvestment amounts of the principal payments we receive on our assets, I would support selling some of our mortgage-backed securities at some point during the reduction period to speed the conversion of our portfolio’s composition to primarily Treasuries.”
Mester spoke with urgency about the need to withdraw monetary stimulus. “While the current extraordinarily accommodative stance of monetary policy was needed to support the economy earlier in the pandemic, that stance is no longer appropriate…..Inflation well above our goal undermines sustaining a strong and inclusive expansion. So the task before us is to remove accommodation at the pace necessary to bring inflation under control.”
Firming policy is needed to sustain the expansion, she emphasized.
Mester prefaced her policy comments with strong expressions of concern about inflation. Noting that the reopening of the economy due to vaccinations has fuelled strong demand, she said “this strong demand came at the same time there were constraints on product supply and labor supply.”
“The imbalances between supply and demand have put significant upward pressures on prices and wages,” she continued, noting that “inflation readings in the U.S. are at their highest levels in nearly 40 years, and nominal wages are accelerating at a faster pace than we have seen in decades.”
She made repeated references to the inflationary influence of tight labor markets, much as Powell did on Jan. 26. “By a number of measures, labor markets are very strong and the demand for workers is well outstripping labor supply.”
“Businesses cite the shortage of labor as a very significant issue and have responded by raising wages, offering signing and retention bonuses, allowing much more flexible work schedules and locations, and speeding up automation,” she went on. “Average hourly earnings grew nearly 5 percent last year, and upward pressure on wages continues as firms scramble to retain and attract workers.”
Mester said “the imbalances between demand and supply in product and labor markets are contributing to the very high inflation readings.”
What’s more, higher labor costs are fueling price increases. “Firms tell us that they are having little trouble passing on their higher costs to their customers,” she said.
Instead of moderating as the Fed hoped, “the supply constraints have persisted, demand has been very strong, and inflation has continued to rise,” Mester said.
This caused Fed officials to revise up their inflation projections in December, but Mester said “even with the upward revisions, the risks to inflation are still tilted to the upside.”
Contact this reporter: steve@macenews.com
Content may appear first or exclusively on the Mace News premium service. For real-time delivery contact tony@macenews.com. Twitter headlines @macenewsmacro.