MNI INTERVIEW- Fed Will Hike Rates To 6% Or More–Gorodnichenko

The Federal Reserve will need to keep raising interest rates more than markets expect because the inflation views that matter most – those of consumers and businesses – are not particularly well-anchored, San Francisco Fed visiting scholar Yuriy Gorodnichenko told MNI.

A streak of hot economic data from jobs to inflation have forced investors to readjust their expectations for the federal funds rate to peak around 5.5%, but Gorodnichenko thinks that’s still too low.

“They will have to keep increasing it – maybe 6%, maybe higher,” said the Berkeley economist, also a research consultant at the European Central Bank, in an interview.

Gorodnichenko worries the Fed is playing with fire by allowing the one-year horizon price expectations of consumers and businesses to far exceed their 2% inflation goal.

Professional forecasters see inflation around 4% to 4.5% over the next year, while households and businesses see it closer to 8%, he said, making monetary policy negative in real terms.

SHIFTING INFLATION WEIGHTS

“We have a window of opportunity. The longer inflation stays high the harder it is to bring it down,” he said.

Price expectations of regular Americans also started to move up a lot faster than those of forecasters, whose predictions Fed officials often point to as a source of comfort, he noted.

“One implication is we have to give more weight to household expectations and firms’ expectations when we think about future policy," he said.

The Fed may also be too optimistic about how soon it can cut rates – even as it pushes back on market expectations for such reductions later this year, he said. The Fed’s December Summary of Economic Projections shows the central bank reducing rates by a full percentage point between the end of 2023 and the end of 2024, which Gorodnichenko said is too sanguine.

WAGES TAME FOR NOW

“They predict that the fed funds rate is going to revert quickly – I wouldn’t be so sure about that,” he said in an interview before Fed Chair Jerome Powell's Congressional testimony on Tuesday. Powell corroborated the notion that rates will need to go higher because inflation and growth momentum are proving more stubborn.

(See MNI INTERVIEW: Fed Could Hike Rates More Than Expected-Hoenig)

The economy has proven more resilient than many forecasters expected and inflation pressures have also turned out to be more stubborn. Payrolls rose more than half a million in January while the Fed’s preferred inflation measure jumped 0.6%.

Job market strength also suggests the Fed can clamp down on inflation without creating a spike in unemployment as a traditional Phillips curve suggests, he suggested.

Wage data shows again that the Fed still has a window to get inflation under control if it takes stronger action, Gorodnichenko said.

“Wage growth is there but it could have been a lot higher given the inflation expectations people have. Recent research suggests the passthrough from inflation expectations to wage growth expectations is very weak,” he said. “That’s good news. But that can change if they don’t do anything.”