MNI INTERVIEW: Fed Likely Needs To Move Rates Above 6%-Mishkin

The Federal Reserve will likely need to raise interest rates above 6% to defeat inflation, and while the economy has so far remained strong it should not buckle if it tips into recession, former Fed governor Frederic Mishkin told MNI.

"I'm a little worried the economy's stronger than expected and that is likely to mean they have to go a little bit higher above 6%," he said in an interview, adding his name to a list of outside advisers who've told MNI recently there's a risk rates will move above 6%.

The drag on GDP growth from last year’s fiscal and monetary policy tightening is fading and that means that a key risk for the economy is a premature reacceleration, he said. "The Fed has to tighten substantially further, and secondly it has to stick to its guns. It can't make the mistake of pivoting just because a recession occurs."

Fed officials have emphasized inflation expectations as a key factor in helping to bring prices and wages down, but Mishkin stressed it will also require cooling the labor market.

MORE RESTRICTIVE

"Monetary policy has mostly only removed accommodation and didn't really get back to neutral until about six months ago and it takes a long time to have an effect," said Mishkin, also a former NY Fed director of research. "Policy is restrictive now but it needs to be a lot more restrictive."

While Mishkin has previously argued, in a 2010 paper coauthored with Jean Boivin and Michael Kiley, that changes in the structure of the banking industry could reduce the sensitivity of the economy to rate hikes, he told MNI that the central bank's conventional tools including the fed funds rate are as strong as ever, but the Fed will have to raise rates higher since it got caught behind the curve.

The long-dormant Phillips Curve between inflation and unemployment has returned with a vengeance and the Fed's failure to pre-empt inflation in 2021 has restored the pre-1985 pattern of greater persistence of movements in both inflation and inflation expectations, he said, pointing to a recent paper produced for the Chicago Booth Monetary Policy Forum.

"It was clear that the Philips Curve was still around and would come back, particularly if the Fed stopped being preemptive," said Mishkin, now at Columbia University. "They thought it was flat and sure enough it's not flat. It's real."

PHILIPS CURVE ALIVE

Fed Chair Jerome Powell Tuesday opened the door for the central bank to accelerate the pace of rate hikes and raise the target range of the fed funds rate more than anticipated just months ago when Fed officials saw a peak rate in the range of 5.1% to 5.4%. (See: MNI: Powell-Fed Rate Peak Likely Higher; Could Quicken Hikes)

Mishkin said he's expecting the Fed's next SEP to be released March 22 to show a fed funds rate peak around 5.6%. "There's more recognition that the Phillips Curve was alive and that they made mistakes, and that's one of the reasons they've been continually raising the SEP forecasts," he said.

"There's a really strong possibility they'll go even higher," he added. "It makes it very likely that a recession will occur. In fact, it would be unprecedented to not have a recession in this context."