MNI INTERVIEW: Fed On Hold, Next Move Could Be Hike-Andolfatto
MNI (WASHINGTON) - Federal Reserve officials have little reason to continue cutting interest rates with inflation still persistently above their target and a strong growth backdrop, former St. Louis Fed economist David Andolfatto told MNI.
“The economic outlook is looking robust. Inflation, especially core measures, seem to be elevated. They might want to cut, but I don’t know how they rationalize it,” he said in an interview.
Andolfatto sees inflation hovering between 2.5-3% for the foreseeable future, in part because of the prospect of continued high U.S. budget deficits. (See MNI INTERVIEW: Global Focus On Fiscal Strains-Ex-ECB Economist)
Not only is there a good chance the Fed could be done cutting rates, he said, the possibility of a rate hike as the next move cannot be ruled out.
“I don’t know if we’re at that stage yet – but the idea that the Fed might at some point have to reverse itself, I’ve been saying for more than a year, because it’s part of what goes into state-contingent policy,” he said.
“Even if we think the prospect of a hike is remote, we will stand ready to hike if we see the data coming in that justifies it.”
The prospect of an increase in tariffs and immigration restrictions coming from the Trump administration add an extra element of complication and uncertainty for policymakers.
“It will be a very uncomfortable discussion. It’s not clear how transitory it will be because that experiment assumes no retaliatory measures,” Andolfatto said.
The decision to stop cutting rates would not be based on some perceived rise in the neutral rate, said Andolfatto, adding that he never saw this as a useful lodestar during his days as policy adviser to former St. Louis Fed president James Bullard. “Did I ever make reference to a neutral rate? Not really.”
THE CHINA FACTOR
Large and persistent budget deficits are likely to maintain upward pressure on inflation, particularly as China emerges as a major trade and military adversary for the United States, said Andolfatto, who now chairs the department of economics at the University of Miami’s business school.
“I think we’re entering into a cold war with China. It may cool off in the near term, it's likely to get hotter. And what we know from history is wars are expensive and they're inflationary,” he said.
“At the same time, you see China's allies trying to disassociate themselves from using U.S. Treasuries. So that has an effect on the demand for Treasury debt. That's basically what forms the core of my outlook – I see the previously disinflationary world has shifted to one of more inflationary pressure.”
It’s hard to envision inflation receding much further against this backdrop, said Andolfatto.
“You look at CBO projections of the deficit – we can't expect the world economy to continue to absorb that degree of Treasury or Treasury issuance without interest rates changing or some inflationary pressure manifesting itself,” he said.
On the positive side, this means the economy is likely to run pretty hot because wartime buildup tends to be consistent with full employment, he said, adding that growth is likely to hover around 2.5% this year.
He expects the labor market to hold up well, particularly in light of existing and potential productivity improvements coming from everything in investment in technology to potentially lighter touch regulation in the pipeline.