MNI INTERVIEW: Ample Slack In US Economy-Ex Treasury Adviser

The path of U.S. inflation has become more uncertain as a large expected fiscal stimulus tests the Federal Reserve's shift toward a more expansionary monetary framework, former Treasury adviser Richard Berner told MNI, although the risk of a sustained surge in prices is moderate with the economy operating well below potential on most measures.

"I don't think we know enough about coming off a period of low inflation and moving toward a higher inflation regime that policymakers have said they want to achieve," said Berner, who was counselor to the Secretary of the Treasury from 2011 to 2013 and started his career as a Fed board staffer.

"The issue for investors is once inflation starts to rise do you start to get some snowball effect with inflation expectations moving higher?" he said in an interview, noting that market concerns over prices are also linked to President Joe Biden's proposed USD1.9 trillion stimulus package now moving through Congress.

Fed officials are likely watching the rise in 10-year yields to post-pandemic highs of as much as 1.39% for signs of whether it signals inflation or a stronger recovery, he added. "Could inflation come back in a way that we hadn't thought about? The answer is potentially."

ECONOMIC SLACK

But ample economic slack should mean that any price surges are temporary even as the economy is likely to rebound and vaccinations permit a return to normality, Berner said. Still, the Fed's new average-inflation targeting strategy, under which it will allow inflation to run above its 2% target for a time to make up for past undershoots, will mean it will be more cautious about tightening policy in response to faster price gains than during past rebounds.

"The Fed won't move as they did in the past-- preemptively to contain inflation," Berner said.

While, as MNI has reported, Federal Reserve officials are coming under pressure to define their tolerance for higher inflation much sooner than expected, the rate has been hovering this year at just above half the official 2% target. Price gains also undershot the target over the bulk of the recovery from the Great Recession despite historically low unemployment below 4%.

HIGHER YIELDS, COOLING STOCKS

The official jobless rate is now 6.3% but Fed Chair Jerome Powell says the actual number when accounting for workers who dropped out of the labor force is closer to 10%.

This weakness has underpinned the Fed's confidence to shift toward a more pro-inflation regime. MNI has reported officials will need to see inflation not just 2% or slightly higher but also the prospect of sustained gains over the Fed's forecast horizon.

Berner, an expert in financial risk who used to head the Treasury's Office of Financial Research, said the jump in yields moderates some of the frothiness in stock markets. The Fed must develop more macroprudential tools to address market risks, he said.

"The rise in rates has slowed the rise in asset prices so we're not rocketing up" for now, he said.

Powell testifies on Capitol Hill this week and is expected to face questions ranging from the likely effects of fiscal stimulus on the economy to the stock market rally. He has downplayed the prospects for inflation and said the central bank is not even close to discussing an exit from near-zero interest rates and monthly bond purchases of USD120 billion.