MNI INTERVIEW: Fed’s Next Move Could Still Be A Hike-Posen

The Federal Reserve is likely to face persistent enough inflation over the next year that it will have to consider raising interest rates further in 2025, particularly as fiscal policy will probably remain supportive of growth, former Bank of England Monetary Policy Committee member Adam Posen told MNI.

The economy’s ongoing strength and ample signs of loose financial conditions, including historically narrow credit spreads, suggests monetary policy is not as restrictive as Fed policymakers suggest, Posen said.

That’s especially true because there’s reason to believe the natural rate of interest has risen, he said, and because fiscal policy is likely to remain stimulative no matter who wins the November presidential election.

“That’s a scenario in which they’re going to have to raise rates,” said Posen, adding U.S. inflation is now more or less stuck around 3% for the foreseeable horizon. “I think it goes sideways to up from here. I have trouble believing policy is tight when direct measures of financial conditions are loose.”

STRONG CONSUMER

The idea that the U.S. economy would fall off a cliff simply because consumers’ excess savings from the pandemic were about to run out was always dubious, and has not been borne out, Posen said.

“For more than a decade prior to the global financial crisis the U.S. ran very low savings rates, so while it was a reasonable guess that savings rates would go back to where they were immediately pre-pandemic it doesn’t mean they had to. They could go lower, and they did,” he said during an interview at a coffee shop near the Peterson Institute for International Economics, of which he is president.

Despite some cracks in auto loan and credit card delinquencies, household balance sheets are still in pretty good shape, he said.

With a jobless rate that has been below 4% for over two years, the longest stretch since the Vietnam War, Fed policymakers have repeatedly argued that monetary conditions are restrictive and thus putting downward pressure on demand. However, hotter-than-expected inflation readings since the start of the year have raised concern that last year’s disinflation has stalled, and officials are now saying they need more time to regain confidence that consumer price growth is moving back sustainably to the 2% target.

FISCAL FORTITUDE

This has prompted investors to radically reconsider their expectations for several rate cuts this year, with markets now reluctantly pricing in just one or two cuts. But Posen thinks even that outlook is overly optimistic, in part because he believes that fiscal policy will remain robust no matter who wins the White House in November – and even under a divided Congress. (See MNI INTERVIEW: Fed Cuts Timeline Pushed Back-Reinhart)

If Joe Biden wins re-election, Posen thinks he will use existing programs like the Inflation Reduction Act and the CHIPS Act to keep the spigots of spending open.

If Donald Trump returns to the White House he would likely boost spending on domestic energy exploration and try to reduce taxes. Trump’s tariff policies, and especially his anti-immigration stance, are likely to have an added inflationary effect, Posen said.

This would be particularly problematic for the Fed to game out because its models tend to downplay the boost from fiscal policy to growth.

“There’s basically a bias in the forecast to assume a steady-state to less-loose fiscal policy over time. Meanwhile, if you read the empirical literature about how fiscal policy cycles go, it tells you the opposite – the second term of any president, whether it’s Biden or Trump, you get fiscal expansion.”