MNI INTERVIEW: Hard To Rule Out More Fed Rate Hikes-Acharya

Stubborn inflation pressures are still plaguing the U.S. economy and making it harder for the Federal Reserve to cut interest rates, with uncertainty so high that even the possibility of additional rate increases cannot be ruled out, a former resident scholar at the New York Fed, told MNI.

“The volatility of interest rates in the markets and the uncertainty people have on inflation are both signs to me that anything must be considered on the table,” said Viral Acharya, also a former deputy governor of the Reserve Bank of India, in an interview.

“It really depends on the inflation trajectory. It looks like the economy is doing well, the labor market is tight. The inflation rate actually is actually bobbing around quite a bit,” he said.

“We just seem to be living in a world of slightly greater uncertainty both on drivers of inflation and the economy structurally, as well as on what exactly the Fed is trying to accomplish.” (See MNI: Fed Messaging Swings Boost Policy Volatility-Ex-Officials)

CONFUSING SIGNALS

Acharya said the Fed appears to have prematurely eased financial conditions by signaling rate cuts in its late 2023 communications, a move that required significant backtracking and sent confusing signals to investors about the likely direction of policy.

“It's not clear to me why, before having achieved the 2% inflation target, there was an attempt to ease the financing conditions which will sort of move you away from attainment of the target in the first place,” he said.

Indeed, markets have swung from pricing in as many as six rate cuts after a dovish December FOMC meeting, but have since reduced their expectations for around three rate cuts this year – potentially even fewer – as officials pushed back on investors’ timeline.

Fed Chair Powell said in Congressional testimony this week he expects the central bank to reduce borrowing costs “at some point” this year, adding officials need a bit more data before gaining enough confidence to embark in a new monetary easing cycle.

“Interest rates, which are a reflection of the financing conditions in the economy as well, in my view, are becoming a bit too volatile,” said Acharya, now a professor at New York University’s Stern School of Business.

REVISITING FRAMEWORK

The Fed has been vague about the time horizon over which it expects to hit the 2% inflation target, Acharya said, adding that the central bank should revisit its average inflation targeting framework implemented in 2020. (See MNI: Fed Review To Rebalance Inflation Targeting-Ex-Officials)

“Some of the communications left investors and everyone wondering what is the horizon, how quickly is the Fed necessarily trying to achieve that target?” said Acharya, a member of the New York Fed’s Financial Advisory Roundtable.

“I hope they reverse the 2020 framework revision. I really don't understand the logic of achieving averages – it has to be based on targets or projected inflation.”

At the same time, Acharya said it would be a bad idea to move away from the existing 2% inflation goal, especially before the central bank has been meeting that target consistently.

He said part of the reason for having a 2% inflation target rather than, say, 4%, is distributional, because higher income households are much better able to absorb somewhat stronger price pressures than poorer ones.

“Most central banks have erred on the side of lower inflation because the upper income segments can deal with 4% Inflation 6% Inflation, their real wage growth will be positive even at that level of inflation. It's really the lower income segment where the higher bouts of inflation become harder to actually deal with,” he said.