MNI INTERVIEW: Fed’s Athreya-Real Rates Might Still Be Too Low

Interest rates adjusted for inflation appear too low to cool the economy enough and get runaway inflation back under control, Richmond Fed research director Kartik Athreya told MNI.

“You could argue real rates are low given the kind of demand that’s out there and the neutral interest rate that would go with it – we still may not quite be in meaningfully restrictive territory, at least in the shorter run,” he said in an interview.

“Theory generally tells you that you need to react to inflation. If inflation comes in above target you still do something, almost robotically. In that neat world of models, it’s the promise to react to inflation that prevents it from happening.”

U.S. consumer price inflation fell to 3% in the year to June, the lowest since March 2021, but core inflation remained a lofty 4.8%, more than double the Fed’s 2% official target. (See: MNI INTERVIEW: CPI Drop Won't Stall Hikes-Ex-NY Fed Economist)

CORE PROBLEMS

Athreya said the drop headline is encouraging but was driven by lower energy prices and easing supply constraints. Core readings are far too high for central bankers to become comfortable or complacent, he said.

“Core measures are still not where the Fed would be comfortable with, annualized to 4+ range, which if you just think back to the pre-pandemic era, it continues to be hard to imagine that this is where we are given the 10 years that came before it,” he said.

“There’s a lot of distance between where the inflation rate is right now and where it has to durably tell us it’s headed."

Athreya likes to track the share of consumer expenditures with prices rising 2% or more and 3% or more. “Those are coming down but they’re still elevated. I’m not ready to take a lot of signal that inflation is safely descending."

SAVINGS TO BURN

Add to that a consumer still comfortable spending with unemployment near historic lows and you get the possibility inflation remains higher for longer than policymakers hope.

“If you look at some of the estimates that are out there you’ll still see a bunch of people with excess savings that they haven’t burned through. So that’s an upside risk that on the consumption side,” he said.

"The one bright spot is even if you go out a little bit further out on the horizon, people are not expecting inflation to be running away over the next two to three years. If you look at the Survey of Professional Forecasters for example, that’s been very stable."

The Fed last month left borrowing costs on hold for the first time since March 2022, but policymakers sharply revised up their estimate of the peak federal funds rate to 5.6%, signaling at least two more hikes. The Fed meets at the end of July and is widely expected to hike by another 25 basis points.