MNI: Fed’s Barkin-Inflation Could Persist Despite Bank Turmoil

The Federal Reserve must remain vigilant to the possibility that inflation worries have become so widespread in the economy that the recent banking turmoil and its drag on economic activity might not be enough to tamp down price pressures, Richmond Fed President Thomas Barkin said Thursday.

“It is possible that tightening credit conditions, along with the lagged effect of our rate moves, will bring inflation down relatively quickly. But I still see three reasons why it could take time for inflation to return to target,” Barkin said in prepared remarks to the Virginia Council of CEOs.

It will take time to figure out whether the recent turbulence in the banking sector, including the failure of a few regional banks, will lead to a broader tightening of credit conditions that would be disinflationary, he added.

“Even resilient banks can impact the broader economy if, to minimize their liquidity risk and protect capital, they choose to tighten access to credit. Research shows that such a pullback would limit consumer spending and curtail business investment. But it is too early to know whether that will happen now, or not,” Barkin said.

The Fed raised interest rates by a quarter point to 4.75%-5% at its meeting last week despite banking turmoil that raised fears monetary tightening may have already gone too far. Still, officials cautiously penciled in just one more rate hike into their quarterly projections as they noted the failures of several banks and fears of contagion could lead to a growth-crimping credit crunch.

(See MNI INTERVIEW: Financial Stress Could Be In Early Stage-Hoenig)

STAYING NIMBLE

Barkin said he supported the hike at the last meeting because he doesn’t think the Fed should back off the inflation fight prematurely. But he said he remains flexible about future hikes.

“If you back off on inflation too soon, inflation comes back stronger, requiring the Fed to do even more, with even more damage. With inflation high, broad-based and persistent, I didn’t want to take that risk,” he said.

“But policy will need to be nimble. If inflation persists, we can react by raising rates further,” Barkin added. “If I am wrong about the pricing dynamics at play, or about credit conditions, then we can respond appropriately.”