– Bullard Explains Dissent In Favor of Higher Funds Rate
By Steven K. Beckner
(MaceNews) – Minneapolis Federal Reserve Bank President Neel Kashkari has built a reputation as one of the more “dovish” Fed policy-makers, but in an essay released Friday, he sounded distinctly less so.
Kashkari, not a voting member of the Fed’s interest rate-setting Federal Open Market Committee this year, still regards high inflation as “transitory,” but said it will take longer to reduce than expected. So, he has markedly increased his projections of how high the FOMC will need to raise interest rates to bring inflation down.
And he wrote that the FOMC may have to be more aggressive than now anticipated if inflation doesn’t retreat from 40-year highs.
On Wednesday, the FOMC raised the federal funds rate 25 basis points after holding them near zero for two years and said it “anticipates that ongoing increases in the target range will be appropriate.” It also announced it will soon start reversing the bond buying it did to lower long-term rates.
FOMC participants, including Kashkari, projected six more rate hikes this year and foresaw the funds rate rising to 2.8 percent by the end of next year – 40 basis points above a downwardly revised 2.4% “longer run” or “neutral” rate.
Earlier Friday, St. Louis Fed President James Bullard issued his own statement explaining why he dissented against the FOMC decision in favor of a 50 basis point rate hike.
Kashkari, writing on the Minneapolis Fed website, acknowledged that, like many of his colleagues, he had argued last year that the acceleration in inflation “as likely due to transitory factors which would soon pass.”
But “that hasn’t happened,” he conceded.
Elaborating on why his expectations proved unfounded, Kashkari broke down how various supply and demand factors have led to a different result.
On the supply side, he recalled that he had argued “labor supply was being held back by a combination of fears of COVID-19, enhanced unemployment benefits and child care issues triggered by school closings” and that labor supply would improve as the pandemic eased.
Kashkari noted “labor supply has materialized,” but said, “I expected this increase in workers to relieve pressure on businesses, supply chains and wages. As more workers came back to work, temporary inflationary pressures would relax.”
“That hasn’t happened with wage growth picking up to around 5 percent and businesses continuing to struggle to find all the workers they need,” he added.
Kashkari also expected supply chains to “eventually sort themselves out as COVID-19 was brought under control, workers returned and companies adjusted.” But he said, “there has been less improvement than I had hoped to see at this point.”
Far from improving, supply constraints could worsen due to geopolitical factors, he warned.
“And now there is a substantial risk of new disruptions in China, which could further challenge global supply chains: COVID-19 cases have exploded in Hong Kong and are now rising steadily on the mainland .…,” he observed, adding, “The shocking invasion of Ukraine makes almost all these problems more challenging with oil and other commodity prices soaring and tremendous geopolitical and economic uncertainty .…”
On the demand side, Kashkari had “assumed the artificially high level of goods consumption we saw during the pandemic would rebalance toward services as the economy reopened and normal activity resumed once the virus started to recede.”
But that hasn’t happened to the extent he expected either. “The virus has receded in the U.S., workers are returning to their offices, and services activity has picked up, but I am surprised that goods consumption hasn’t pulled back…..”
Nor have households spent down the extra savings which multiple doses of fiscal stimulus helped fuel as fast as Kashkari thought.
“I expected those excess savings to be spent down fairly quickly, especially for lower-income households,” he said. “The saving rate for households has fallen back down to around pre-pandemic levels, but it doesn’t appear that households are dissaving …”
“It appears they are funding it out of current income,” he continued. “That suggests to me that this robust economic activity and the associated high inflation may be sustained and in fact might not be transitory.”
Kashkari concluded with two possible explanations for persistently high inflation. One is that “these demand and supply imbalances are in fact still transitory but will simply take substantially longer to normalize than I had expected (and longer than we can tolerate without running the risk of destabilizing inflation expectations).”
His second possible explanation is that “the massive fiscal and monetary intervention in response to COVID-19 has moved the economy to a higher-pressure, higher-inflation equilibrium, with people earning more and spending more than before.”
What’s more, “wealth effects” from past asset increases may be “leading people to be more confident and simply spend more.”
“Either way, the FOMC must act to bring the economy back into balance,” he said.
Although monetary policy “operates with a lag,” Kashkari said “forward guidance can have an immediate effect” and said the Fed’s rhetoric and rate projections are designed to supplement actual rate hikes and help reduce inflation expectations.
“The FOMC has already made a profound shift in the past six months with its forward guidance on the path of the federal funds rate and the balance sheet, and I believe the SEP we just released is sending a strong signal that further reinforces our commitment to achieving our inflation target,” he said. “The first hike we announced this week demonstrates that we will follow through on our guidance with action.”
Kashkari said he has “made large adjustments to my own expected federal funds rate path over the past six months.”
In the FOMC’s September Summary of Economic Projections, he said he submitted a funds rate projection of zero to 0.25 percent for year-end 2022, then increased it to 0.50 to 0.75 percent in the December SEP. In the March SEP, he said he increased it further to 1.75 to 2.00 percent.
Kashkari estimated the “longer run” or “neutral” funds rate at 2.0%.
Monetary tightening may have to be more or less aggressive, depending on which of his postulated inflation explanations turn out to be true, he said.
“If my first explanation of the enduring high inflation noted above is right (that it will still prove transitory but take much longer than expected), then I believe the FOMC will need to remove accommodation and get modestly above neutral while the inflationary dynamics unwind,” he said.
“However, if my second explanation noted above is right (that the economy is in a high-pressure, high-inflation equilibrium), then the FOMC will need to act more aggressively and bring policy to a contractionary stance in order to move the economy back to an equilibrium consistent with our 2 percent inflation target.”
“Over the course of this year, while we are moving to what I expect will be a neutral policy stance, we will get information to help us determine how much further we may need to go,” he added.
Bullard, in his earlier statement, said he dissented because he wanted a 50 basis point rate hike and an immediate start to balance sheet shrinkage.
Elaborating, he said, “the U.S. economy has proven to be especially resilient in the face of the pandemic,” and “despite geopolitical risks, the U.S. economy is currently projected to continue to grow at a pace comfortably above its long-run potential growth rate during 2022 and 2023.”
“This above-trend growth is likely to strengthen labor markets further, and U.S. labor markets are today already stronger than they have been in a generation…,” he added.
Noting that the price index for personal consumption expenditures, at 6.1%,, is running 410 basis points above target, Bullard said “the burden of excessive inflation is particularly heavy for people with modest incomes and wealth and for those with limited ability to adjust to a rising cost of living.”
Bullard said, “the combination of strong real economic performance and unexpectedly high inflation means that the Committee’s policy rate is currently far too low to prudently manage the U.S. macroeconomic situation.”
“Moreover, U.S. monetary policy has been unwittingly easing further because inflation has risen sharply while the policy rate has remained very low, pushing short-term real interest rates lower,” he continued. “The Committee will have to move quickly to address this situation or risk losing credibility on its inflation target.”
Bullard went on to contend that the FOMC needs to “try to achieve a level of the policy rate above 3% this year.”
“This would quickly adjust the policy rate to a more appropriate level for the current circumstances,” he said.
“The Committee has successfully moved in this manner before,” Bullard noted, recalling that “in 1994 and 1995, the Committee made a similar discrete adjustment to the policy rate to better align it with the macroeconomic circumstances at that time. The results were excellent.”