MNI INTERVIEW: Fed Already Well Behind The Curve On Cuts -Tracy
Former Dallas Fed executive vice president and senior adviser Joseph Tracy discusses the U.S. economic outlook.
The Federal Reserve should have lowered interest rates by now to keep monetary policy from tightening further and help ensure a soft landing, Joseph Tracy, who spent more than two decades in leadership roles at the Federal Reserve Banks of New York and Dallas told MNI.
The inflation-adjusted target rate for the U.S. central bank has been increasing over the past year despite the perception that the FOMC has stayed on the sidelines. With signs that economic activity is weakening and the labor market loosening, the Fed's benchmark rate should be following the progress of inflation downward, Tracy said.
"By doing nothing in the face of disinflation they’re allowing policy to tighten," he said. "They're falling behind the curve."
The Dallas Fed trimmed mean PCE inflation rate, a measure of underlying trend inflation, has fallen to 2.9% from 4.1% last July, when the Fed last hiked interest rates. That means the real policy rate has increased by 1.2 percentage points in just under a year, said Tracy, who had been principal policy adviser to then Dallas Fed President Robert Kaplan until 2022.
"That’s a meaningful tightening of policy. As a rule of thumb, you should adjust the nominal rate by more than the decline in inflation. I don’t see the reason why the committee has not reduced rates in light of this pretty substantial decline," he said. "They could have made three cuts by now." (See: MNI POLICY: Fed Policy Looks Tight, Bolstering Case For Cuts)
HARD LANDING RISK
Keeping rates too high for too long risks a hard landing, Tracy said. The jobless rate has risen half a percentage point over the past year and other data suggest growth momentum is slowing. (See: MNI INTERVIEW: Fed Will Stay Patient On Rocky Road To 2%-Evans)
"It’s very hard to see turning points in the real economy. Generally we don’t see with perfect clarity that weakness is coming, so if they’re trying to achieve a soft landing, easing will mitigate the risk that the economy does sink into a downturn," he said.
The FOMC has been waiting to gain greater confidence that inflation is moving sustainably to 2% before cutting rates, but such a bar is too ambiguous, Tracy argued.
"The problem I have with basing policy on a degree of confidence is it’s very difficult for markets to make an assessment of the Fed’s future rate decisions," he said. Speculation over what will make the FOMC more confident also creates unnecessary interest rate risk, he added.
"It’s easier to base decisions on realized gains in inflation toward target. And you can say, if data evolve differently, we’ll react -- so that markets understand future rate cuts are not baked in the cake," he said.
"If it allows the Fed to achieve a soft landing, that also builds the credibility of the Fed."
ELECTION MOTIVATIONS
Employing a clearer reaction function would also eliminate doubt over the Fed's motives for cutting rates as the presidential race heats up, said Tracy, currently a nonresident senior fellow at the American Enterprise Institute.
"Even if a decision to cut in September is based on their internal perception of becoming much more confident, their motive might still be open to interpretation. It would make it easier for people to say it's motivated by a desire to influence the election," he said.
"So even if the committee decided it would be appropriate to cut in September, given how it might be perceived, maybe it's better to play it safe and delay the cut."