MNI INTERVIEW: Inflation Drop Warrants Fed Pause - Ex IMF Econ

U.S. inflation pressures are abating sufficiently to allow the Federal Reserve to be patient in figuring out whether to raise interest rates further, making this week’s pause a warranted move, former IMF chief economist Simon Johnson told MNI.

The Fed kept rates on hold Wednesday for the first time since it started to hike in March of 2022, in a range of 5%-5.25%, although officials also raised their projections for peak rates to imply at least two additional increases this year.

“The inflation numbers will recede – we’re still seeing echoes from the supply shocks. I think those are going to become less intense, which would support the view that interest rates are already at the right level for now, and a level that’s consistent with returning to the Fed’s medium term inflation target,” Johnson, a professor at MIT and co-author of the new book ‘Power and Progress’ said in the latest episode of MNI’s FedSpeak Podcast.

“So I think they should be patient.” (See MNI INTERVIEW: Fed Done Hiking, Inflation To Drop-Ex-Staffer)

Johnson said concerns about why inflation has persisted for long as it has are legitimate. But he was optimistic that recent declines, with May’s CPI at a two-year low of 4%, will continue.

“I think inflation is under control,” he said, adding that wage pressures are not “a primary driving force at this stage.”

ECONOMIC PAIN FOR WHOM?

Johnson pushed back against the notion, often cited by top policymakers, that the economy must incur significant pain in order for inflation to be reined in.

“I think that’s a very dangerous and inappropriate framing for monetary policy. When they say pain in the labor market or damage to the labor market these are euphemisms for higher unemployment and pressing down the wages of lower-income people,” he said.

“The idea that you necessarily have to inflict pain on those people is really unappealing – and I don’t really think it’s true. I think there are plenty of ways an economy like this can have a softer landing, you can bring inflation under control.”

He said fears that a deep credit tightening might result from the regional bank turmoil in March had not materialized.

“There were legitimate fears but they were more negative than justified. The credit tightening, we’ve come through that and it’s not like it’s pushing us into a deep recession or something like that,” he said.

FINANCIAL STABILITY BALANCE

Johnson suggested the Fed still had not quite worked out how to balance monetary policy against financial stability concerns.

“It’s ironic that Fed is taking their foot off the brakes because of financial stability issues that they themselves helped cause,” he said.

In addition to reversing 2018 reforms that loosened financial rules on medium-sized banks, the Fed likely needs deeper institutional changes to reduce the influence of banks on the Federal Reserve system, Johnson argued.

“It’s very uncomfortable and inappropriate that banks sit on the boards of regional Feds. There’s no other part of American public life where anyone would regard it as acceptable that the people who are being supervised sit on the board that hires and fires the top management of the supervisor,” he said.