MNI INTERVIEW: Lagging Fed May Need 75BP Hikes To Catch Up

U.S. inflation has gotten so far out of the Federal Reserve’s reach that more extreme steps like interest rate increases of 75 basis points and pushing the federal funds rate above levels currently considered neutral may become necessary, Ricardo Reis, an academic consultant to the Fed system, told MNI’s FedSpeak Podcast.

Price expectations are at serious risk of becoming unanchored as businesses and workers start to factor inflation prospects over longer-term horizons, said Reis, a professor at the London School of Economics who also advises the Bank of England and the Riksbank.

After hiking rates by 0.75 percentage point over the last two policy meetings, the Fed has signaled at least another two 50bp rate hikes in June and July. Markets are pricing in a fed funds rate that will end the year around 3%.

“More likely than not it seems not to be enough and there will be further tightening by which I mean not just delivering on the increases that have already been announced but probably having to do somewhat more,” said Reis in the podcast.

“That implies some 50-basis-point increases in several meetings and even, why not, 75 basis points. Especially because if we see that inflation starts being ingrained that will be a sign that the words of the last few months are not enough and if so then actions and big hammers have to be taken and that is indeed shock measures such as increases of 75 basis points.”

Reis said it’s unclear whether inflation pressures have peaked, echoing comments Cleveland Fed President Loretta Mester made to MNI in an interview Monday. (See MNI: Fed's Mester Sees Upside Risk To Inflation)

CREDIBILITY TEST

He saw the next few months as crucial to figuring out how entrenched inflation expectations have become given how prices are rising far more quickly than even the most extreme estimates by Fed officials. U.S. consumer prices jumped 8.5% in the year to April.

“Even if one looks at any generous interpretation of what the Federal Reserve thought was tolerable or admissible, we are many percentage points above that in terms of the inflation we’ve achieved,” said Reis.

“I like to point to a speech by Charlie Evans of the Federal Reserve Bank of Chicago given in 2011 when he said imagine having the inflation rate above 5% for several months, any self-respecting central banker would have their hair on fire. We are talking at the point in which every member of the FOMC has their hair on fire, and they should, it is that bad.”

Reis said the rest of this year will be a decisive test for the ability of the Fed, by words and action, to curb the spike in inflation to 40-year highs.

“Over the next seven months of months, it’s going to crucial (to gauge) the extent to which the credibility of monetary policy has indeed been harmed insofar as we will see firms setting prices with the expectation of high and continuous inflation, and workers asking for wages with the expectation that inflation will remain very high throughout 2023,” Reis said.

“We are now at that second-round stage where inflation either becomes entrenched in prices and wages in U.S. society and economy or not. We will see that over the next few months. I think the Fed realizes that and this is why I think we see, rightfully, such a strong reaction.”