Official rates are still nowhere near neutral despite Fed assurances, Andrew Levin tells MNI.
High and persistent inflation will force Federal Reserve policymakers to raise interest rates much more than they are currently projecting, perhaps nearly twice as much, ex-Fed board economist Andrew Levin told MNI.
Fed Chair Jerome Powell said in his July press conference that the June Summary of Economic Projections, which shows the federal funds rate peaking at 3.8%, was still the best guide available for where official interest rates are headed.
But that view is too sanguine because it is unclear that inflation has peaked and, even if it has, any decline will likely be choppy and slow, said Levin, a former Fed board economist for two decades until 2012, including two years as a special adviser on monetary policy strategy and communications.
“The more likely scenario is that core inflation continues running in the neighborhood of 5, 6, 7%, and really to bring inflation down the Fed is going to have to raise the federal funds rate up to 5, 6, 7% or more,” he said in an interview. “The longer this goes on the harder it’s going to get because the more entrenched the expectations are in the wage- and price-setting behavior.” (See MNI: CPI Shortens Odds Of 75-BP Hike In Sept-Ex Fed Staffers)
One of the problems, Levin said, is that the Fed sees itself as already having raised rates to an effectively neutral level, even though rates are deeply negative when adjusted for inflation.
“If inflation is running at 7 to 8% then they want cost of living increases of 7 to 8%, and then it’s very hard for firms to raise their prices by much less than 7 to 8% and you just get the same cycle that we had in the 60s and 70s,” he said. “What that means is the markets are probably totally wrong and that probably by this fall it will be clear the Fed still has a long way to go.”
Levin said the Fed is not being straight with markets, which raises its own set of dangers.
“There’s a chance here that the markets are going to totally lose confidence in the Fed and that will make things go even more haywire,” he said.
LABOR MARKET PAIN
Making matters worse, despite real rates still at negative levels, Levin said that it’s not accurate to say the labor market is too tight despite stronger-than-expected monthly job growth such as that registered in July. He said the Fed seems to have forgotten about its new framework language focused on “broad and inclusive” employment, adding that workers are set to pay much of the price of the hikes to come.
“We’re not really at maximum employment, it’s not accurate to say the labor market is overheated,” Levin said, noting that wage increases are not keeping up with inflation.
“It’s true that the unemployment rate is low on average, but just like in the past it hasn’t fully reached some groups within the economy and there are still people out of the workforce where if things continue to improve hopefully labor force participation would continue to recover,” he said. “If the labor market were overheated we’d see wages growing faster than inflation, that’s definitely not what we’re seeing.”
By claiming the job market is too hot, the Fed is effectively asking workers to make sacrifices, Levin added.
“They should hold down on their wage increases and that’s how we’re going to manage to reduce inflation, by having workers hold back on their cost-of-living increase,” he said.
“We’re probably in for a tough period ahead. We might have to have shortfalls from maximum employment for a while in order to get inflation down. I’m not arguing against that,” he said. “But like a good doctor, they have to be honest with the patient’s family.”