Ex-Governor Stein says risk of inflation expectations surge means Fed can no longer "look through" energy price spikes.
(Repeats article first published on July 15)
The Federal Reserve will likely keep raising interest rates even if the economy slows considerably as long as headline inflation remains elevated because the risk of unanchored expectations means it can no longer look through energy price shocks, ex-Fed governor Jeremy Stein told MNI.
Fed officials have made clear that fighting 40-year high inflation is their top priority regardless of a possible slowing in the economy, which policymakers still hope can avoid a recession. .
“It sounds like they’re not really giving themselves that out the way they talk. They’re just saying we want to see headline inflation come down,” Stein said in an interview.
June CPI surged by more than expected to a new 40-year high of 9.1%, keeping the pressure on the central bank to remain aggressive. Moreover, the job market continues to deliver strong growth, defying concerns about an imminent recession.
The strong figure has cemented expectations for a 75-basis-point rate hike, which Stein said is likely the baseline for the July meeting, but also raised speculation about a possible full-percentage-point move. (See: MNI INTERVIEW: High Bar For Fed To Back Off Big Hikes-Athreya)
NO MORE LOOK THROUGHS
Stein said the Fed does not have the luxury of “looking through” energy price shocks as it has in the past.
“If there’s some persistence in inflation because of continued oil or other commodity price sort of stuff, they’re kind of committed,” Stein said. “Normally they’d look through it but they’ve become so concerned, reasonably so, concerned with expectations. The average person’s expectation doesn’t allow them to separate between supply and demand shocks so you have to be a bit more blunt at this point.”
Against that backdrop, Stein said engineering a soft landing will be an all too delicate task for central bankers as they figure out how much rates need to rise for policy to become restrictive.
“It’s not to say a soft landing is impossible, but a lot of things have to go right. A little bit of supply shock, a little bit of bad luck with oil, say, forces them to tighten and it’s going to be a problem. If inflation expectations get entrenched, it’s a real problem,” he said.
“If you want the really pessimistic story, think back to the financial crisis, unemployment went up to 10% and core inflation only came down 50 basis points or so.”