A more aggressive 75 bp hike is unlikely even as the Fed plays catch-up to inflation, ex-Fed governor says.
The Federal Reserve will probably raise interest rates by half a percentage point in the next three meetings in order to tame a surge in inflation and ensure longer-run price expectations don’t take off, former Fed board governor Randall Kroszner told MNI.
“They’re on a path to raise rates most likely for the next three meetings in 50-basis-point chunks and then it’s maybe time to reassess," he said in an interview. "They want to make sure that inflation expectations don’t become unanchored. They have the opportunity now relatively quickly to make sure they don’t.”
Recent comments pushing back against the prospect of a pause in rate hikes from Lael Brainard, the Fed’s new vice chair, clearly cemented that prospect, Kroszner said. “This is a clear pivot from Lael who had been more dovish. That was not an accident. It’s really about expectations management.”
The Fed needs to act aggressively to catch up with an inflation rate that, at 8.3% in April, is near its highest levels since the 1980s, said Kroszner, who left the Fed in 2009 and is now deputy dean and professor of economics at the University of Chicago’s Booth School of Business.
“Short-run inflation expectations are certainly quite high but if you look at the intermediate expectations five- to ten-years out, they’re not much different than the upper ranges of where they’ve been over the last decade,” he said. “They have the luxury of being able to raise rates significantly while the unemployment rate is still below 4% and inflation expectations haven’t become unanchored.”
75BPS A STEP TOO FAR
Still, Kroszner argued that moving by 75-basis-points as some market participants have speculated the Fed might would be a step too far.
“They’ve set expectations up to be 50 basis points per meeting,” he said, adding that this puts the central bank on a sufficiently fast path toward its goal of getting to neutral levels or a bit higher.
“If you look at the infamous dot plot, getting in that range of 2-½ to 3 is where all the members think is neutral or slightly above neutral. They’re on a clear path to get to basically to the mid-2s by September and probably 3 by the end of this year.” (See: MNI INTERVIEW: Fed Should Slow Hikes As Neutral Nears--Wright)
TIMES HAVE CHANGED
Kroszner said the Fed needs to act promptly to send a clear message to a generation of Americans who have not experienced high inflation – or even an aggressively restrictive central bank.
“In the old days people understood that the Fed needed to take the punchbowl away. For the last 25 to 30 years the perception of the Fed’s job is to prevent downside risks,” he said. “The challenge is that you’ve got a generation of policymakers and politicians, market participants and just the general population that doesn’t understand that that’s part of the Fed's role.”
Kroszner said the Fed was aware of the risk of market volatility as it tightens policy, even though it would try to avoid significant disruption by clearly telegraphing its short-run policy path.
“They need to move boldly without causing tumult in the markets, but they’re willing to tolerate that tumult in the markets if they can get to what they think is a soft of softish landing. And I think that really requires them to move quickly so they don’t have to raise rates as much as if they waited and then inflation expectations become entrenched.”