MNI INTERVIEW:Kaplan Urges Easy Fed Policy Despite Market Bets

Dallas Fed President Robert Kaplan said in an interview Friday it might be more difficult to predict the path of inflation after the Covid-19 pandemic but stressed that the Federal Reserve should take aggressive actions to promote a swift recovery despite potentially feeding market imbalances.

He expects headline inflation to end the year around 1.8% as the economy gets back on its feet with the help of strong monetary and fiscal support, and noted that supply constraints will play a role in firming prices for a while until they resolve themselves. Yet, technological disruption, which has only accelerated in the pandemic, is likely to sap firms' power to raise prices, he said.

"How those cyclical and structural forces play out, the jury is out on that," he said. "As opposed to say 20 years ago when you'd be confident that cyclical forces would dominate, today I think it's hard for us to predict how those two forces will play out, other than to say those structural forces are having and will continue to have some muting effect on inflation."

For now the Fed needs to keep its eye on the prize. "While we are in the teeth of the pandemic, we need to be aggressive," he said.

"As the events unfold in 2021 and 2022 and beyond, I have in the back of my mind that monetary accommodation is not free and there are tradeoffs that come with it," namely the "potential excesses and imbalances that could be created," he said. But that debate should be left until well after the pandemic when "we're actually approaching achievement of our dual mandate goals down the road."

OUTLOOK IMPROVING

The economic outlook has already improved over the past month and could "firm more" if fiscal support and vaccinations stay on pace, Kaplan said, adding "we have a chance at a very strong year."

New variants of the virus and a fumbled vaccine rollout present "considerable risks to the outlook," but if those are off the table, consumer mobility and engagement could come in the second half of the year and much earlier than the achievement of herd immunity, Kaplan said.

His improved base case since the start of the year sees GDP growth of approximately 5% in 2021, with the unemployment rate in December near 4.5%. Whether that will constitute "substantial further progress" toward the Fed's goals of full employment and stable prices, the FOMC's bar for tapering asset purchases, Kaplan declined to opine.

"I'm going to be very focused on how the economy is unfolding and I'm going to avoid being rigid or pre-determined about how the economy might unfold. I don't have any, and I won't have any, specific timeline in mind. I'm going to let events and the facts on the ground dictate how the economy is evolving this year and into next year," he said.

The Fed's September commitment to keep rates near zero until inflation has reached 2% and is on course to moderately exceed it, a decision to which Kaplan dissented, remains concerning, he said. "As we approach full employment and meeting our inflation goals, the neutral rate is likely to be moving up. As we keep rates at zero, we're actually increasing accommodation," he said. "I'm sure we'll have lots of deliberations when the time is appropriate, but I do have that concern."

INFLATION BETS

Market expectations about inflation rightly reflect anticipation about a rollout of vaccinations and additional fiscal support from the Biden administration, but that "doesn't mean that's how things are going to turn out," Kaplan said.

Conversations with businesses in the Dallas Fed district have proven to be as important as data and surveys in assessing the recovery during the pandemic, Kaplan noted. A number of businesses that did not have pricing power a year ago are reporting having some now, he said, but "they're also skeptical how persistent that's going to be when we get back to normal."

Shortages in semiconductors, wood products, packaging product and metals are just some examples of the kinds of supply constraints that are likely to plague the economy this year, he said. At the same time, "we're still under capacity, and technology and technology-enabled disruption are accelerating, and may limit prices."

Investors are positioning for higher inflation as a possible outcome, he said. "I note it, am cognizant of it, but I also know how things unfold may not happen the way markets are suggesting."