MNI INTERVIEW (RPT): Fed Should Slow As Neutral Nears-Wright

(Repeats article first published on May 26)

Federal Reserve policymakers may consider slowing the pace of interest rate hikes as they approach a neutral rate of interest, although officials have divergent views as to where that key juncture lies, Minneapolis Fed Research Director Mark Wright told MNI.

“The real calculation that a lot of people will be making is do we need to go above the neutral rate, and what do you think the neutral rate is,” Wright said in an interview. His comments came just after Fed minutes released Wednesday showed the FOMC believes policy may have to become restrictive in order to rein in inflation, meaning the fed funds rates would be above the level considered neutral.

“It would make sense to slow down as we approach that number. But people’s ideas of where that number is will vary and they might disagree in their assessment as to just how far above that number they have to go.”

Wright expects inflation to ease over the course of this year but concedes upside risk to that forecast based on overseas developments like the war in Ukraine and China’s Covid shutdowns. (See also: MNI: Fed’s Mester Sees Upside Risk To Inflation)

“If you look at our core measures of PCE, we’d like to see those monthly numbers drop down to 0.2% and then a little bit below 0.2% over the course of the year,” said Wright, who advises Minneapolis Fed President Neel Kashkari and attends FOMC meetings.

“I think some of the moderation in demand that we’re producing by tightening policy will help with that. But some of those oil price fluctuations will make it into core.”

U.S. CPI inflation jumped to 8.3% in the year to April, while the Fed's preferred PCE measure climbed 6.6% in the year to March, both well above the central bank's 2% goal. In response to the surge in prices, the Fed has raised interest rates by 75bps and indicated another 50bp rate hikes are likely at the next couple of policy meetings, in June and July.

“Although what we’ve done so far in terms of raising interest rates is pretty modest, and only a step on the path we’re walking, the forward guidance we’ve given about what’s coming has clearly shown up in much tighter financial conditions and much tighter mortgage rates, which is one of the primary ways in which Fed policy affects the economy,” said Wright, noting that the Fed would also allow its balance sheet to contract.

THE SEARCH FOR NEUTRAL

The high degree of uncertainty surrounding the path of inflation means the Fed should remain flexible in its policy direction as rates near the 2% level that marks the lower end of estimates of the long-run neutral rate, he said.

“If the data is clear that the economy is slowing and slowing quickly in September then I imagine there’ll be a move to not raise further – maybe even begin to think about not just pausing but eventually it might be necessary to lower them,” Wright said. “On the other hand if inflation is still high and potentially getting higher then at that point we might go ahead with further increases.”

Wright said the central bank cannot rule out the larger, 75-basis-point rate hikes that have already become a focus of market speculation, but added that they are not under active consideration under current circumstances.

“I think in the back of everyone’s mind people know that’s a possibility if necessary. The committee will do whatever it takes to get inflation under control,” he said. “That would include (75bp moves) if necessary but I don’t think that’s something that’s at the front of everyone’s mind right now.”