MNI INTERVIEW: Demand Boom Keeps Fed Patient For Longer-Koenig
Demand growth indicators are stuck at around 5.5%-6%, eroding confidence that policy is restrictive, former Dallas Fed principal policy adviser Evan Koenig tells MNI.
The Federal Reserve appears inclined to wait a while longer for higher rates to cool the economy as long as inflation doesn't reaccelerate, though measures of demand growth show no signs of slowing nine months into holding rates at a 23-year high, former Dallas Fed principal policy adviser Evan Koenig told MNI.
Assuming near-term trend inflation is 3% – the latest reading of the Dallas Fed trimmed mean PCE inflation rate – with a fed funds rate target of 5.25%-5.5%, the real rate of interest is a little over 2%, just above current estimates of the neutral rate that range from 1.1% to 2.2%, Koenig noted.
"They believe policy is restrictive, and they’re inclined to wait longer with the expectation it will start to impact real activity or inflation or both," Koenig said in an interview.
"If inflation levels off where it is, it gives the committee an opportunity to exercise patience. Even if policy is mildly restrictive, the longer you maintain it, it's more likely than not we’ll start to see some demand growth slowing going forward, but my confidence is diminishing."
JUST MILDLY RESTRICTIVE
The Fed's benchmark rate has been at its estimated peak since July, but measures of nominal demand growth continue to stay in a 5.5% to 6% range, Koenig noted.
Personal consumption expenditures growth accelerated to 6.0% on a six-month annualized basis from 5.8% over the past 12 months, while aggregate weekly payrolls, which combines hiring, wages and hours worked for private-sector employees, is rising at a 5.6% rate, unchanged over the past six months from the past year.
Those figures are consistent with a 3.5%-4% trend inflation rate if potential growth is assumed to be about 2% a year and could signal more upside risk to inflation, Koenig said.
"The proof of the pudding is in the eating, and looking at nominal spending growth and demand growth, if we really were tight, that ought to be slowing," he said. "That’s the most convincing evidence that policy isn’t very tight."
ADVERSE SCENARIOS
Nominal demand measures capture both the impact of higher rates on inflation and real growth, and policymakers are looking for effects on either end, Koenig said.
"If you saw notable deceleration in real growth or increases in the unemployment rate or vacancy rate, something that would suggest inflation is coming down in the future, that might cause you to stick with the current policy.," he said.
"If we saw a series of inflation numbers on a six-month basis start moving up a half percentage point, that would certainly be enough for me to think about raising rates, unless there’s clear signs real growth is significantly slowing." (See: MNI INTERVIEW: Fed Will Cut Rates More Sparingly In '24-Weber)
Getting inflation back down to 2% without derailing growth might be difficult to avoid, he said. "If the economy is moving ahead slowly enough to get inflation to move down from where it is to 2%, it’s very easy to misjudge what policy should be, and there are shocks that hit the economy."
If layoffs start to rise, the economy can quickly gather downward momentum, and it will be difficult for policymakers to react nimbly. (See: MNI INTERVIEW: Fed Set To Start Easing By YearEnd-Haslag)
"Keeping inflation at 3% and having the economy on a glide path of moderate growth is one thing, but to make progress on inflation and pull off a soft landing remains a big challenge."