MNI INTERVIEW: Fed Risks Overcooking Rate Hikes, Fuhrer Says

Federal Reserve officials are at increasing risk of tightening monetary policy too far and causing an unduly deep recession because they fail to see how much inflation is still supply driven and underestimate the lagged effects of rate hikes, former Boston Fed executive Jeff Fuhrer told MNI.

“I think this is one of the biggest risks at the moment,” said Fuhrer, a former senior policy advisor at the Boston Fed, now a fellow at the Eastern Bank Foundation, on MNI's FedSpeak podcast.

The Fed has raised interest rates by 300 basis points this year, including three consecutive 75-basis-point increases, with another expected in November. Stronger-than-expected CPI data has ratcheted up expectations for a higher terminal rate. (See MNI: Ex-Officials Now See Fed Rate Peak At 5% Or Higher)

“It’s not that we know they’re going too fast. So far they’re only up to the 3% to 3.25% range. But the risk of overdoing it is an important one,” Fuhrer said. “Lags of monetary policy are not to be taken lightly. They could be driving the car by looking in the rearview mirror.”

SUPPLY RIPPLES

Fuhrer thinks more of the current stubbornness in inflation, reflected in a new 40-year high core CPI reading of 6.5% in September, is driven by supply disruptions than many Fed policymakers believe.

“If it’s not really incredibly strong demand which is pushing inflation up to an underlying rate of 4% or higher, then more than likely at some point the supply effects are going to fade out and inflation will come back down,” he said.

“They could be raising rates vigorously when in fact the seeds of declining inflation had already been sown. That is a risk. The risk is they could cause a much larger recession than they envision or than I think we need to handle inflation.”

Fuhrer stressed that the Fed’s own tightening measures, which also include shrinking the balance sheet, are being compounded by simultaneous aggressive rate hikes from major central banks around the world.

“With a global tightening of rates and a possible overtightening by the Fed that risks not only a U.S. but a global recession,” he said.

But persistently high inflation readings could paint the FOMC into an uncomfortable corner.

“Could the Fed get to 5% or above? Absolutely. They made a change of about a percentage point at the September meeting. With one bad additional bad CPI report, the market is notching things up further.”

As for what it will take to slow the pace of rate hikes or even pause them, he said every economic indicator has now taken on enormous importance.

“It’s going to be very data dependent. If you see two or three months in which you see key categories in the CPI flatten out and decline and the headline numbers are distinctly lower, they might pull back on that,” he said.

FINANCIALLY STABLE

Fuhrer said he’s not worried about credit risks from households and businesses, which he argued have a much bigger cushion this time around than going into the Great Recession.

As for risks to Treasury market liquidity, he said the Fed has the tools it needs to control any hiccups.

“The Fed is quite on top of that and has pretty good tools for injecting liquidity when they need to. To some extent they can do that without disrupting their policy trajectory because they’re using administered rates,” he said.