MNI INTERVIEW: Fed Can Cut Gradually If Jobs Stay Strong- Kohn

MNI (WASHINGTON) - Federal Reserve officials can afford to cut interest rates gradually in coming quarters barring unexpected deterioration in an economy and labor market that remain strong by many measures, former Fed Vice Chair Don Kohn told MNI. 

“Unless the economy is weakening or labor markets are weakening, or that they anticipate, I would expect them to go a bit more slowly. There’s no reason to speed up if they don’t see signs of weakening,” said Kohn, who spent 40 years at the U.S. central bank, in an interview. 

“If the labor market follows the path they expect I’d be surprised to see a 50. If it weakens from that, sure they could throw in a 50 and they probably should.”

By choosing to kick off the rate cut cycle with a 50 basis point cut, Fed Chair Powell was “trying to get ahead of a weakening labor market curve, trying to take some of the restraint out of monetary policy” rather than signaling an aggressive rate path ahead, Kohn said. 

“He made it pretty clear that this was going to be the first of a number of steps, although the pace and timing would be determined by incoming data moving towards neutral.”

NEUTRAL AN OPEN QUESTION

How deep this rate cutting cycle will ultimately be depends whether the Fed is reacting to a soft landing or a downturn. It will also hinge on shifting perceptions of the neutral rate or R-star. 

“The open question is what’s neutral. I’m surprised that their estimate of neutral hasn’t crept up more than it has,” he said. Kohn advised Fed Chairman Ben Bernanke throughout the 2008-2009 financial crisis and served as a key adviser to former Fed Chairman Alan Greenspan.

The Fed’s long-run dot, seen as a proxy of the neutral rate, was revised up by a tenth of a percentage point from June to 2.9% in September. 

“My guess is that neutral is above where they have it, somewhere between 3-4%,” said Kohn. “My expectation, which is consistent with what (Powell) was saying too, is that neutral is going to be higher than it was before 2020. We've got these huge deficits, government spending, crowding out private interest-sensitive spending, investments in chips and renewables spurring that." 

The median FOMC view of long-run neutral declined slowly in the 2010s, reaching 2.5% in the second half of 2019, with some discussion then that R-star could be somewhat negative. This week, officials' estimates for the long-run neutral rate ranged from 2.4% to 3.8%, the same as in June. 

WATCHING WAGES 

Like Fed policymakers, Kohn is fairly certain that inflation is heading sustainably back to the central bank’s 2% target. (See: MNI FED WATCH: No Hurry To Cut, But Easing Starts With A Bang)

“They’re right to be reasonably confident that inflation - which is already in the mid-2s, pretty close to the target, with the labor markets roughly in balance, with inflation expectations anchored around 2% - there's every reason to think that it's gradually going to make its way back to 2, which is what they're predicting.”

For now, it looks like the worrisome “last mile” on inflation will not be a major hurdle, but that will still depend on the path of wages ahead, said Kohn, noting major unions are still bargaining for fairly significant pay rises. 

“I’d keep my eye on those wage increases, which continue to moderate. If those start to turn around in a sustained way then I’d be worried (about) the last mile,” he said. 

As for the possibility of below target inflation, Kohn said Fed officials would likely tolerate it as long as it seemed, “pardon the expression, transitory.”

“They don’t want a persistent undershoot,” he said.