MNI: Mester Wants Fed Funds Rate Near 2.5% This Year

The Federal Reserve should raise interest rates by about another 200 basis points this year and further in 2023 to combat inflation and prevent expectations from becoming unanchored, Cleveland Fed President Loretta Mester said Tuesday.

“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,” Mester said in prepared remarks.

“My path is somewhat steeper than the median path in the March Summary of Economic Projections of FOMC participants, which also has the funds rate moving above its longer-run level next year,” she said.

The Fed raised interest rates a quarter point last week and policymakers on balance penciled in seven rate hikes for this year. Chair Jerome Powell has also signaled the prospect of more aggressive half-point moves to tackle the fastest price gains in four decades.

Mester said the Fed should act swiftly to begin reducing its USD8.9 trillion balance sheet, which Powell has signaled will happen in May.

“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.”

While the Fed can't directly affect supply-chain driven inflation, she said it could act on the demand side to prevent inflation expectations from getting out of control. “Absent such action, with inflation already at very high levels and demand outstripping supply, there are rising risks that too-high inflation will become imbedded in the economy and persist.”

Price pressures that had initially been concentrated in the goods sector had broadened in a worrisome manner, Mester said. “Eighty percent of the components used to compute the Cleveland Fed’s median CPI have year-over-year inflation rates of 3% or more, and nearly 60% of components have inflation rates of 5% or more,” she said.