MNI INTERVIEW: Fed Bracing For Risk of Persistent Inflation

The Federal Reserve must be ready to respond quickly to the threat of more persistent inflation, so it makes sense to speed up the pace of QE taper at the December meeting, Richmond Fed research director Kartik Athreya told MNI.

“If that’s the base case, that the inflation that we’re experiencing right now will be a little bit more durable, then I think you have to prepare the ground,” Athreya said in an interview. “It makes a lot of sense to me that you want to at least be in a position to hike.”

Because QE works best in economic emergencies, the danger of winding it down more rapidly now is probably low, he said.

“There’s a big gain from being able to move your key policy rate without a great deal of cost at this moment in time,” Athreya said, echoing strong hints from Fed Chair Jerome Powell this week that the Fed is strongly considering a quicker taper.

Initial hopes that inflation pressures would be fleeting and narrowly linked to the pandemic are giving way to concerns about more entrenched price pressures, he added. “As the year has moved on, we’re observing a broader-based acceleration of prices."

He thinks economic growth in 2022 will come in between 3.5% and 5%, highlighting just how robust but also uncertain the outlook remains.

OMICRON AS A SUPPLY SHOCK

Omicron might actually worsen inflation pressures even as it potentially softens the economy’s brisk growth momentum, Athreya added.

“You might fail to get the kind of abatement of the supply constraints that are binding precisely because this is yet another force that will help sustain the rotation toward goods and away from services that we’ve kind of been experiencing for a couple of quarters,” he said.

The consumer price index surged 6.2% in the year to October while the Fed’s preferred PCE inflation measure was up 5%.

“Inflation I think will continue to remain elevated, I would suspect over the next year or so, above the 2% average that the Fed is targeting almost certainly for the next year or so, and then after that we’ll have to see,” he said.

Athreya said rising inflation expectations in both consumer surveys and market compensation measures were also a source of concern. Five-year breakevens, for instance, had recently been hovering above 3%.

“If inflation goes up in some sustained way, that’s a job for monetary policy. It cannot be said credibly that something happening in the labor market is ‘driving inflation.’”

CLOSE TO FULL EMPLOYMENT

The U.S. labor market is already close to fully healed given rapid recent job gains and a near-unprecedented vacancy-to-unemployment ratio, Athreya said, in line with other comments from former officials.

“I don’t know that we’re so far away from what you’d call full employment,” he said. “You’re seeing wages move up fairly smartly across lots of groups. We’re stabilizing in terms of the labor market being fairly tight.”

He does not expect labor force participation to rebound to its pre-pandemic highs because of early retirements and long-run structural shifts.

“We should not think about numbers like 63% and beyond as so realistic,” Athreya said. “Instead, where we are at right now doesn’t look so far away to me from what one might have projected based on the trend pre-Covid. So as that trend reasserts itself, my expectations for participation are not completely met, but they are largely met.”

Still, he added, there are certain groups like women for whom labor force participation remains especially depressed because of pandemic-linked caregiving needs.