MNI INTERVIEW: Fed To Miss Inflation Goal For Years-Rosengren

The Federal Reserve will likely miss its 2% inflation target for three years and may need to raise the federal funds rate above neutral but it will need to avoid supersized rate increases and be cautious later this year, former Boston Fed President Eric Rosengren told MNI.

"I am concerned that over the next three years it's going to be difficult for the Federal Reserve to get back to its 2% target," he said in an interview Thursday after the release of February's consumer price index. "Both my risk of inflation and my risk of a recession have gone up, because I just think it's going to be very difficult given all the shocks hitting the economy, and the fact that we're at full employment, well above target, and that implies raising rates relatively quickly."

He added that "when the Federal Reserve raises rates quickly, it's much harder to determine when to slow down and when to stop and whether the economy on its own starts taking on momentum to slow down more than anticipated."

The FOMC needs rate hikes at "consecutive ones at least in the middle of the year and evaluate where the world is but it's quite likely that they'll be doing 25 basis points at every meeting through this year," said Rosengren, characterizing the situation as tricky and "perilous" given the faster rate-hiking cycle and crosscurrent of economic and geopolitical risks.

"If they increase interest rates 25 basis points at every meeting then, while the labor market is quite tight, if people start expecting the Fed to tighten too much then the labor market can get weak pretty quickly."

Ideally the tightening policy would have started earlier, he said, a mistake made in part because of the Fed's new flexible average inflation framework that encourages patience and that did not anticipate developments over the last year.

50BP MOVES UNLIKELY

The Ukraine crisis is an argument for being cautious in case the economy unexpectedly slows later this year from supply shocks, and added uncertainty suggests avoiding taking bigger steps, said Rosengren, who led the Boston Fed for 14 years until September last year and is now a visiting professor at MIT.

(See: MNI: War Makes Fed More Cautious on Tightening--Ex-Officials)

"I would think it's pretty unlikely, that given the geopolitical concerns, the volatility in markets, that raising more than 25 basis points per meeting would seem an admission of waiting too long and then in effect panicking," he said. "It's probably not a good idea to start doing 50-basis-point increments, given the uncertainty that we're seeing in the world right now."

And while expressing confidence the Fed is going to tighten enough to prevent a wage-price spiral, Rosengren suggested that the outlook may still mean bringing rates above neutral, which the median FOMC participant sees at 2.5%.

"Unless you think that inflation expectations are really well anchored, when wages and salaries are growing fast enough, it's very hard to get back to 2% inflation without causing the labor market to have more slack than it currently does," he said. "The way you do that is to raise rates above the neutral rate."

ASSET SALES

The Fed should push to shrink its nearly USD9 trillion asset portfolio more aggressively this year and consider selling assets, he said, while expressing concern about the shape of the Treasury yield curve. "I am a little worried that the yield curve is flattening and that will certainly be true if there's a series of 25 basis point increases."

"The bigger question facing the Committee is whether they actually want the long end to go up more and that's not a passive strategy of rollout. That is trying to sell or swap longer duration securities," he said. "That would be a surprise to the market but given where the excess demand is it's something that they'll at least have to consider" and "if the goal is to actually get longer term rates up, then that's what you have to do."