– FOMC Voter Says Policy Must Stay Restrictive Until Sure Inflation Headed To 2%
By Steven K. Beckner
(MaceNews) – St. Louis Federal Reserve Bank President Alberto Musalem said Thursday that the risk of inflation worsening is greater than the risk of labor markets deteriorating, as he advocated a continued “restrictive” monetary policy stance.
Musalem, a voting member of the Fed’s rate-setting Federal Open Market Committee, said he could support a resumption of interest rate cuts if the labor markets were to weaken, but only if inflation expectations were well-anchored.
He expressed concern that inflation expectations are rising by some measures in remarks to the Economic Club of New York, although he later told reporters that so far he’s not prepared to conclude that inflation expectations have, in fact, become unanchored.
Musalem does, however, believe risks are to the upside on inflation: “I perceive the risk that progress on inflation could stall as being greater than the risk of substantial labor market weakening.”
Fed officials as a group have indicated they intend to take their time in deciding whether or when to lower short-term interest rates. Almost uniformly, though with some nuances, they have made clear they will focus primarily on combating inflation so long as it remains well above the central bank’s 2% target.
Officials have allowed for easing if there were to be “unexpected weakness” in labor markets. But for now, most officials, including Musalem, have echoed Chair Jerome Powell in calling labor markets “solid.”
That’s not a uniform sentiment, though. Atlanta Fed President Raphael Bostic took a slightly different view in an essay published Thursday, in which he cited “clear softening in the labor market.”
The FOMC cut the key federal funds rate three times from September to December last year, but left it unchanged in a target range of 4.25% to 4.5% on Jan. 29, while continuing to shrink the Fed’s balance sheet.
After the January 28-29 meeting, Chair Powell said the FOMC had decided that, after 100 basis points of rate cuts, “it’s appropriate we do not be in a hurry to make further adjustment.” He repeated that basic message last week in two days of testimony on the Fed’s semi-annual Monetary Policy Report to Congress.
Minutes of the meeting released Wednesday confirmed a mood of caution predominated.
They say, “participants observed that the Committee was well positioned to take time to assess the evolving outlook for economic activity, the labor market, and inflation, with the vast majority pointing to a still-restrictive policy stance.”
“Participants indicated that, provided the economy remained near maximum employment, they would want to see further progress on inflation before making additional adjustments to the target range for the federal funds rate,” the minutes continued.
Most officials thought “the current high degree of uncertainty made it appropriate for the Committee to take a careful approach in considering additional adjustments to the stance of monetary policy.” Among the factors “supporting such an approach included the reduced downside risks to the outlook for the labor market and economic activity, increased upside risks to the outlook for inflation, and uncertainties concerning the neutral rate of interest, the degree of restraint from higher longer-term interest rates, or the economic effects of potential government policies.”
Musalem echoed the FOMC’s generally patient tone in his Thursday speech.
“I believe that modestly restrictive policy will remain appropriate until there
is confidence that inflation is converging to the FOMC’s 2% target,” he declared. “If labor market conditions were to deteriorate while inflation expectations remain anchored at a level consistent with 2% inflation, I believe policy could be eased further.”
However, although Powell and others have maintained that inflation expectations are “well-anchored, at least at the long end, Musalem took a less cheerful view.
“Market and some survey measures indicate that near-term expectations of inflation have risen notably over the past three months, while the University of Michigan survey shows some
firming of longer-term consumer inflation expectations,” he said. “I will be monitoring these
developments closely for signs that short-term expectations of higher inflation could be feeding into medium- to longer-term inflation expectations.”
Musalem sought to clarify his view on inflation expectations later in response to reporters’ questions, saying, “I don’t think we’re unanchored …. I think inflation expectations. are anchored at present.”
But he left no doubt he remains concerned about the level of inflation itself. Pointing to the January rise in the consumer price index, which left it up 3.0% from a year earlier overall and 3.3% on a core basis, he said “that would imply a core inflation rate of 2.6% and a headline rate of 2.4% on a 12-month basis” for the Fed’s preferred inflation gauge, the price index for personal consumption expenditures (PCE).
So, he said there is “more work is required to achieve price stability.”
Asked what he needs to see on inflation to justify additional rate cuts, Musalem said, “I’d like to get more confidence that inflation is on a downward trajectory toward 2%…simple as that…”
“I’d like to see inflation continue to make progress consistently (toward 2%) and stay there…not just a fleeting convergence…,” he told reporters later. “I’d like to understand the elements of supply and demand that make it a durable convergence.”
And Musalem added, “Right now I see the risks of inflation staying above target skewed to the upside.” He nevertheless said he expects “inflation continues to converge toward 2%,” but only if “monetary policy remains moderately restrictive.”
Meanwhile, on the maximum employment side of the Fed’s dual mandate, Musalem said “labor market conditions remain solid, and I see risks to employment as roughly balanced. After softening through the first three quarters of 2024, the labor market has stabilized and has recently shown some signs of strengthening.”
Musalem presented alternative scenarios for monetary policy.
Explaining his “base case,” he said, “I expect inflation will continue to converge to the FOMC’s 2% target and the labor market will remain near full employment. This baseline scenario requires that monetary policy remains modestly restrictive until inflation convergence is assured, at which point the policy rate can be gradually reduced toward the neutral level as convergence progresses…..”
“Around this baseline scenario, the risks of inflation stalling above 2% or moving higher seem skewed to the upside,” he added.
Musalem then presented an “alternative and plausible scenario in which inflation ceases to converge, or rises, at the same time the labor market weakens.” He said that possibility “must also be considered.”
As for the potential impact of tariffs and other non-monetary policies, he said, “From the
standpoint of monetary policy, it could be appropriate to ignore, or ‘look through,’ an increase in the price level if the impact on inflation is expected to be brief and limited.”
“However, a different monetary policy response could be appropriate if higher inflation is sustained, or longer-term inflation expectations rise,” he went on. “In that scenario, a more restrictive path of monetary policy relative to the baseline path might be appropriate.”
In the current environment, Musalem said “the stakes are higher than they would be if inflation was at or below target. With robust growth, a solid labor market, supportive financial conditions, underlying inflation above 2%, and some measures of inflation expectations recently rising, the risk that inflation expectations could become unanchored is higher than it would be if the economy was operating with slack and if consumers and businesses had not recently experienced a period of high inflation.”
While saying inflation expectations have not yet become unanchored, he warned, “I would be especially concerned by evidence suggesting they are becoming unanchored.”
In other comments, Musalem suggested the Fed’s policy framework, which is now under review, could stand to be changed. He observed that the current framework, which was rewritten in 2020 to put greater emphasis on getting then below-target inflation up and maximizing employment, was put in place at a time of great Fed concern about hitting the zero lower bound for interest rates. That framework “is not well designed” for the current environment of elevated inflation, he said.
Earlier, the Atlanta Fed released an essay by its President Raphael Bostic, in which he cited “clear softening in the labor market” while also forecasting “a bumpy course” toward 2% inflation.” And he wrote: “The economy is strong, monetary policy is well positioned, and today’s pervasive ambiguity calls for caution and humility as we continue working to bring about price stability and maximum employment for the American people.”
The day before, Bostic told Yahoo Finance he wouldn’t take a 2025 rate cut “off the table.”
Chicago Red President Austan Goolsbee, like Musalem a current FOMC voter, sounded a bit more sanguine about inflation Thursday morning. “The CPI number was not great,” he said. “The PCE number … is probably going to still be not great, but it’s not (going to be) as sobering as the CPI number.”