MNI INTERVIEW: Fed Must Hike To 6-8% For 'Restrictive'-Lacker

The Federal Reserve will need to raise rates to at least 6% and as high as 8% because policymakers are underestimating the extent of an inflation problem that has already kicked off a wage-price spiral, former Richmond Fed President Jeffrey Lacker told MNI.

Officials are still too sanguine about just how persistent and broad inflation pressures have become, causing them to misjudge the extent of additional monetary tightening needed to bring price growth back to the Fed’s 2% target, Lacker said.

“I think they’re going to end up over 6%, they’re too optimistic about inflation coming down,” he said. “Six to 8% is the range to be thinking about in terms of restrictive policy.”

Lacker said measures of inflation expectations one year out and of wage growth suggest underlying inflation is in the vicinity of 5.5-6%.

“They need to be higher than that by a reasonable margin. So if that’s the run rate on inflation right now, between five and six, they need to be over seven to have hope of slowing inflation down,” Lacker said in an interview.

NOT YET RESTRICTIVE

The FOMC is expected to raise interest rates for a seventh time this year this week, but policymakers have telegraphed the intention of reducing the size of the hike to 50 basis points following a torrid pace of 75 bps for four straight meetings.

While the pace matters less than the destination at the moment, Lacker worries Fed officials might be tempted to pause rate increases before inflation is convincingly on its way down.

“The real rate hasn’t gotten positive. They still haven’t gotten policy into a restrictive zone by any reasonable definition,” he said.

Ex-Fed officials and investors currently expect the federal funds rate to peak around 5%, a level Lacker says will fail to make policy restrictive enough to control price pressures.

“The longer we go without inflation showing demonstrable signs, both current realized inflation and what people expect for the next year, of falling substantially below where it is now, the longer they have to keep going,” said Lacker.

“Given their behavior it wouldn’t surprise me if they take a pause before they really ought to, before inflation has come down. But inflation is not showing signs of responding, they need to respond with alacrity.”

Fed Chair Jerome Powell surprised markets with a dovish tone in recent remarks at the Brookings Institution, and markets are keen to see what tone he strikes at this week’s press conference.

Recent comments from officials suggest some, though not all, believe the worst of the inflation surge might be behind them as goods prices turn lower and supply constraints ease. Headline CPI eased to a still-elevated 7.7% in the year to October from what thus far was the cycle peak of 9.1% in June.

INFLATION HASN’T PEAKED

Lacker said it’s still too soon to say whether underlying inflation has actually peaked, given that what started as localized pressures in a goods sector hugely boosted by the pandemic turned into a broader more persistent problem, spreading to worker demands for higher pay to catch up. (See MNI INTERVIEW: US Wage Pressures Likely To Be Longer Lasting)

“What has to be worrisome is that wage rates are still gaining at a very healthy pace. That’s going to be the predominant factor in so-called core non-housing services. There, there doesn’t seem to be much hope on the horizon,” Lacker said.

He said some Fed officials were adopting too narrow a definition of a wage-price spiral in which the rate of increase of pay keeps increasing, fueling inflation which in turn feeds back to more wage growth.

“Short of that, if wages are growing at a certain rate and inflation is at a certain rate and the growth in wages is keeping inflation from falling and the growth in prices is keeping the rate of wage inflation from slowing – that’s pretty much the definition of a spiral,” he said. “You have a mutually reinforcing equilibrium that binds you into a higher inflation rate. I think we’re there, we’ve satisfied that broader definition.”