A recession will be hard to avoid, ex-Richmond Fed President Jeffrey Lacker told MNI's FedSpeak podcast.
(Repeats article first published on June 10)
The Federal Reserve may have to push interest rates much higher than markets expect in order to contain an inflation problem that it allowed to get out of hand, former Richmond Fed President Jeffrey Lacker told MNI.
Fighting inflation from behind means the Fed will need to do more than it would have otherwise to ensure policy is actually restrictive enough to tamp down demand.
“My sense is they have to go to 5% before they can really think they’re at neutral,” said Lacker in an interview with MNI’s FedSpeak podcast. Even at the aggressive current pace of 50 bps per meeting, “they’re not going to hit that until the middle of next year.”
Fed officials have said they would like to push official rates, currently in a 0.75% to 1% range, to more neutral levels “expeditiously.” But policymakers have defined neutral in nominal terms on an assumption that the inflation rate eventually returns to the Fed’s 2% target. That’s a big assumption, said Lacker.
“Three percent is fine as a neutral rate if inflation already is 2%. But if not, then 3% isn’t neutral. What is neutral depends on what the current inflation rate is, what the going rate is, what it’s expected to be in the next couple of quarters.”
SIX MONTHS BEHIND
Lacker said the Fed is six months behind the curve on interest rate policy and should have started tightening back in September, when it first became obvious that inflation was more than a passing phenomenon.
Instead, Fed Chair Jerome Powell and his colleagues delayed rate rises until the end of a lengthy tapering process for asset purchases, which Lacker argued was needless and costly.
“By the September meeting the data was very clear that they needed to move. But they were hamstrung by their forward guidance and by this commitment to taper asset purchases. That’s what held them up to March,” he said.
“I think they’re six months behind the curve. They’re making up for it with speed and haste. But it’s not an immediate offset because you can’t take back the fact that expectations have seeped into markets, wage rates accelerated over the winter and firms have become accustomed to pricing in cost increases, passing them on as price increases.”
Waiting too long means the Fed has increased the chances of a policy error that leads to recession and rising unemployment, said Lacker.
“I’m somewhat pessimistic about their ability to bring inflation down without causing a recession. It strikes me as highly unlikely that they’re going to be able to do that,” he said.
“The signs of inflation coming off its peak are extremely tentative, nothing to take to the bank. It seems very unlikely that they’re going to get inflation down to what their forecast was at the last meeting before the beginning of next year.
Indeed, CPI jumped 8.6% in the year to May, dashing hopes that inflation had peaked in March. In that context, Lacker added, “The fall is way too soon to talk about a pause” in rate increases.