- Rates Will Need to Stay ‘Higher For Longer’ – ‘For Some Time’
- Strong Labor Market, Other ‘Bullish Factors’ Give Fed ‘Room” To Battle Inflation
- Rejects ‘Bad Idea’ Of Settling for Inflation Above 2%
- U.S. ‘Vulnerable’ to Recession but Should Be Able To Avoid It, Barring Major Shocks
By Steven K. Beckner
(MaceNews) – St. Louis Federal Reserve Bank President James Bullard said Tuesday that broadly higher inflation requires an “abrupt and forceful” response from the Fed which will entail keeping interest rates high “for some time.”
Bullard said recession is a risk if some shock hits the global and domestic economies but said the strength of the labor market and other “bullish factors” should give the Fed “room” to reduce inflation to its 2% target without undue economic pain.
Bullard, a voting member of the Fed’s policymaking Federal Open Market Committee, said it would be a “bad” and “dangerous” idea for the Fed to accept inflation above 2% as the price of avoiding economic weakness.
He said high inflation has put the Fed’s credibility at risk; so, it must maintain a restrictive policy stance to preserve it.
Bullard, who has been more vociferous than most in advocating aggressive Fed action to reduce inflation this year, did not say how high rates will need to go or for how long, but said the sense of the FOMC now is that the federal funds rate needs to go to around 4 ½% — a percentage point more than in the spring.
Bullard joined his fellow FOMC members in approving a 75 basis point hike in the federal funds rate last Wednesday. It was the third straight move of that size and took the funds rate to a target range of 3 to 3.25% and was accompanied by a dramatic upward revision of rate projections. In their revised Summary of Economic Projections, FOMC participants envisioned the funds rate rising to a median 4.4% by the end of this year and to 4.6% by the end of 2023 – sharply higher than in the June SEP.
Powell told reporters, “we need to bring the federal funds rate to a restrictive level and keep it there for some time.” He vowed to move to a restrictive stance “quickly” and to “keep at it until we’re confident the job is done.”
Bullard did not diverge from Powell or the FOMC consensus in remarks to a Barclays-CEPR International Monetary Policy Forum in London,
Downplaying the moderation in headline inflation, he said, “we’re missing on our inflation target on the order of 600 basis points or more,” despite lower energy prices. He noted that the core price index for personal consumption expenditures is still “in the 6% range” and that even the Dallas Fed’s trimmed mean index, which takes out the very highest and very lowest price increases, is running 4.4% from a year ago and “shows no sign of turning around.”
Steep rent increases are playing a big part in keeping inflation well above target, he observed.
Therefore, Bullard concluded, “We have a serious problem in the U.S.; we’re missing our inflation target, and the credibility of our inflation targeting regime is at risk.”
“This is a serious problem …,” he said. “We need to make sure we respond to it appropriately (so as to) not replay the volatile era of the 1970s.”
Meanwhile, on the “maximum employment” side of the Fed’s dual mandate, Bullard said “the labor market is doing very well” with the unemployment rate at 3.7%. “A lot of good things are happening on the labor market dimension … (and) there’s no slacking off on that so far ….”
Noting that most economists estimate the “natural” rate of unemployment to be between 4 ¼ and 4 ½%, if not higher, he contended that “even if inflation was at 2%. and we had a normal monetary policy going on, you would still expect the unemployment rate to return to natural level, which would be higher than that today.”
Because “we’re doing very well with that part of the mandate,” Bullard said, “that gives us room to try to take care of the inflation problem as soon as we can while the labor market is still strong.”
Bullard also pointed to high levels of wealth and savings as insulating the economy in the face of rising interest rates and tightening financial conditions.
“I think these factors plus strong labor market (mean) we do have room to get inflation under control at a relatively fast pace and reduce the risk of” repeating the experience of the 1970s, when double digit inflation forced the Fed to raise rates so much that the economy went into recession, he said.
Inflation can’t just be blamed on energy prices or commodity prices,” said Bullard. “It has broadened and … spread into the rest of the economy.”
This “requires an abrupt and forceful response by the Fed to get inflation under control,” he continued.
Not only must the Fed continue to raise rates, getting inflation down to 2% will “take time” and will “mean higher for longer rates,” Bullard said.
When the St. Louis Fed chief was asked whether the FOMC would be prepared to accept some overshooting of inflation if it were to get down to a 3-4% range rather than insist on continuing to push it down to 2%, he fiercely rejected the idea.
“I’m hostile to this,” he retorted, adding that he has been “hearing some chatter about this.” He said, “messing around with the inflation target” once inflation gets closer to 2% is “a bad idea” that risks leading “back to the 70s.”
“We don’t want to do this …,” he went on. “To have a major central bank deviate from the international standard (of 2% inflation)” would cause “chaos …. It’s a dangerous concept.”
Bullard was also skeptical of the so-called “Phillips Curve” view that inflation can only be reduced at the cost of much higher unemployment.
He said the evidence for a Phillips Curve trade-off between inflation and unemployment has been “very tenuous” over the last 20 years. Rather, he said, the key to controlling inflation is to “keep inflation expectations under control,” and he said he is “encouraged’ by the fact that inflation expectations have not risen sharply.
Bullard said the real trade-off in the fight against inflation should be accepting less consumption today in exchange for more consumption in the future.
Putting the Fed’s rate hikes into perspective, he observed, “We have raised funds rate a lot, but we started … at very low rate …,”
“The 300 basis points we’ve done so far is close to the 1994 effort by the FOMC,” he continued. “I like to cite the ‘94 cycle because that one was successful .… It set the economy up for a stellar second half of the 1990s …. I am hopeful we can get a similar performance this time.”
With its latest 75 basis point rate hike, Bullard said the funds rate “has arguably moved into restrictive territory … above the level consistent with a long-run neutral policy where inflation is at 2% and expected to remain at 2% and unemployment is at the natural rate.”
“The policy rate would be 2.4% in that idealized word,” he continued. “Now we’ve moved above that level—that long-run neutral level — with more to come at future meetings.”
Because financial markets have anticipated and priced in future Fed rate hikes, Bullard said “that means we have better chance of success … (because) we got a tighter policy in place sooner through market pricing …. We have a better chance of success with less disruption to the economy than we would have had.”
But he stressed, “we will have to stay at that higher rate for some time to make sure we’ve got inflation under control.”
Asked about recession risk, Bullard was relatively optimistic, although he said “macroeconomic shocks we can’t imagine at this point … could send us into recession. That’s something we have to take on board.”
But he discounted the inversion of the yield curve as a predictor of recession.
“Recessions are caused by shocks …,” Bullard said, conceding, “We are vulnerable … we have below trend growth … and will have below-trend growth next year. So we’re vulnerable to something else happening that we can’t anticipate right now.”
He suggested the greatest risk could come from shocks that might trigger a “global recession” that could then “possibly drag the U.S. into recession.”
“That’s not my base case, but (something) could easily happen that could impinge on U.S. output and send us into recession … but there are some bullish factors that would suggest we’ll be able to avoid it.”
What’s more, “the fact that inflation is expected to decline is helping us a lot,” he said. “I’m hopeful that will materialize and become true … I’m looking forward to better inflation numbers.”
Bullard’s comments are just the latest in a post-FOMC swirl of official commentary.
On Monday, in her first public speech since becoming voting Boston Fed President on July 1, Susan Collins said, “Returning inflation to target will require further tightening of monetary policy, as signaled in the recent FOMC projections. It will be important to see clear and convincing signs that inflation is falling, and I will continue to assess the range of incoming data, both quantitative and qualitative, as inputs to my future policy determinations.”
Cleveland Fed President Loretta Mester, another voter, said Monday the Fed needs to be “resolute” in tightening monetary policy. She didn’t say how much more tightening will be needed, but suggested she will err on the side of doing more rather than less,
The tightening steps since March have been “relatively fast,” but “given the current level of inflation and the outlook, I believe that further increases in our policy rate will be needed,” she said. “In order to put inflation on a sustained downward trajectory to 2 percent, monetary policy will need to be in a restrictive stance, with real interest rates moving into positive territory and remaining there for some time…..”
Mester said “high inflation is proving to be more persistent, and more restrictive policy will be needed and for longer to ensure that inflation expectations do not move up and that inflation moves back down…,”
Mester said she’s “going to be very cautious and not assume that one or two improved readings on inflation mean inflation is on a downward path or that inflation expectations are firmly anchored at our goal when expectations measures are elevated.”
“Wishful thinking cannot be a substitute for compelling evidence,” she elaborated. “So before I conclude that inflation has peaked, I will need to see several months of declines in the month-over-month readings. I will also guard against being complacent that longer-term expectations are well anchored …. (E)rroneously assuming that longer-term inflation expectations are well anchored at the level consistent with price stability when, in fact, they are not is a more costly error for the economy than assuming they are not well-anchored when they actually are.”
Earlier Tuesday, non-voting Chicago Fed President Charles Evans said “reducing inflation to a level consistent with the Fed’s 2% objective will require a period of restrictive financial conditions,” which “will generate below-trend growth and some softening of labor market conditions and restore better balance between supply and demand conditions in the U.S.”
Citing the SEP, Evans said, ”most think we’re looking at something like another 100 to
125 basis points of rate increases this calendar year,” with a further rise next year.
He said the funds rate should be judged in real terms relative to inflation: “With the median federal funds rate projected to be 4.4% by the end of the year and with core inflation next year forecast to be 3.1%, the real federal funds rate would be something like 1.3%.”
“This is above the 1/4 to 1/2 percent range most FOMC participants see as
the long-run real neutral rate, and so by this calculation, it’s clearly restrictive,” Evans continued. “And though the estimates are subject to a great deal of uncertainty, the reduction in our balance sheet is worth something like an additional 35 to 50 basis points of policy restraint.”
But Evans suggested “downside risks” may require an eventual halt to monetary tightening.
“Given that the funds rate was essentially at zero just seven months ago, this has been
quite a pivot in monetary policy. In light of this expeditious repositioning—and because the full effect of tighter financial conditions takes time to show through to output and
inflation—at some point it will be appropriate to slow the pace of rate increases and
eventually let policy rates sit at a plateau for a while in order to assess how our policy
adjustments are affecting the economy.”
Evans said, “we must be watchful and ready to adjust our policy stance if changes in economic circumstances dictate.”