MNI INTERVIEW: Policy Lags Argue For Fed Pause, Blinder Says

The FOMC is likely to leave its benchmark interest rates unchanged next week, but a "really bad looking" CPI report could still prompt a surprise quarter-point increase, former Federal Reserve Vice Chair Alan Blinder told MNI, adding he would urge policymakers not to raise rates any further.

"The FOMC is beginning to divide into dovish and hawkish factions, and the worse the CPI report, the more it strengthens the hawks’ hands. The better the report the more it strengthens the doves’ hands. Chair Powell is right in the middle," he said in an interview. (See: MNI POLICY: Fed Most Divided Since Start of Hikes, More Loom)

"When the Fed started on this quest to push the inflation rate down, everybody on the Fed knew they were late getting started and they’d have to go quite a bit higher," he said. "But now where they are, there are lots of live questions over whether and why to go higher or to stop right here."

The FOMC has lifted its fed funds rate to a 5%-5.25% target range in little over a year and is set to update its three-year projections at its June meeting. Futures traders expect just a 28% chance of a quarter-point move next week, though the peak rate is priced slightly higher at 5.285% by August.

POLICY LAGS

Prices are still growing too fast, but waiting for inflation to fall to 2% to stop raising rates would result in deflation, Blinder said. The PCE price index rose 4.4% in April or 4.7% excluding food and energy prices.

"What we learned from decades and decades of data before the pandemic is that the effect on inflation came after the effect on real growth," Blinder said. "It’s the lags argument, and the weak evidence that the economy is showing signs of slowing, that wages and prices are showing signs of moderation -- certainly not enough yet on prices, but some signs."

Conventional central banking wisdom says it takes 18 to 24 months for inflation to normalize after tightening policy, and Blinder said he's not yet convinced that the pandemic has changed that.

"To the extent that the present is like the past -- and that is of course a big question -- we really wouldn’t expect the effect of tighter money on inflation to be showing through very much now," he said.

WAGE GROWTH DECELERATING

To judge the outlook for inflation, the Fed is looking at real growth and the amount of slack in the labor market and wage behavior.

The May jobs report was "mixed" with employers adding over 300,000 workers while households reported a fall in employment, but a drop in self-employment -- a volatile category -- appeared to account for a significant part of the discrepancy, Blinder noted.

That various measures of wage growth are showing signs of deceleration is a more persuasive signal of disinflation in the pipeline, he said. "Wage growth is trending down quite mildly, but it’s there."

MEETING BY MEETING

With a sharply divided committee, Powell will likely say as little as possible about the outlook for the policy rate next week, despite speculation that the hawks on the committee will push for a July hike, Blinder said.

"I wouldn’t expect prose suggesting that they’re on pause for a period of time, though they may be," he said. "It's especially smart for Powell to maintain maximum optionality and not give a statement that leans strongly either in the direction of a good chance of tightening in July or very little chance. I don’t think they’ll come out either way."