MNI INTERVIEW: Prudent For Fed To Hike Another 50-100BP - Reis

The Federal Reserve could soon decide to cease interest rate hikes and keep them elevated for a prolonged period but it would probably be better for policymakers to raise them further to make sure they quash inflation in a timely manner, Ricardo Reis, an academic consultant to the Federal Reserve Bank of Richmond, told MNI.

Reis said more hikes would ensure the central bank keeps expectations anchored in the face of an inflation outlook that is improving gradually but still leaves underlying price pressures well above the Fed’s 2% target, a situation which threatens policymakers’ credibility.

It would also allow rate cuts sooner than a policy that maintains the fed funds rate in the current 5.25%-5.5% range for a prolonged period in order to achieve passive tightening as inflation falls further.

“I would lean more on the side of hiking more with the idea of cutting faster. I get nervous about accepting an inflation episode that lasts four years or longer,” said Reis, a professor at the London School of Economics who previously advised the New York Fed and is also an advisor to the Bank of England and Sweden’s Riksbank.

FORK IN THE ROAD

“Instead of talking about keeping rates where they are for another year, did we not learn that kind of forward guidance only has a limited impact? If that’s the case, why don’t we just hike more now, let’s go to 6, 6-½, and then we also cut much sooner.”

Reis acknowledged that recent dovish signals from a number of officials point to a growing desire within the FOMC to keep interest rates where they are, though some like Gov. Michelle Bowman are still calling for additional increases in borrowing costs.

One possible compromise could be to deliver just one more quarter-point hike.

“Either we say we’re going to stop at 5-½ and stay here for quite a while, which strikes me as probably the winning view right now, versus the other view which is no, let’s hike a little more so that we can cut also a little bit sooner.” (See MNI INTERVIEW: Powell Opens Door To End Of Fed Hikes-Weinberg)

TOO SOON

Another problem with keeping rates where they are now is that it almost immediately forces policymakers to discuss the timing of an eventual cut, which is problematic both because that kind of forward guidance is not especially robust and also because it is still too soon to be contemplating easing policy.

“We’re still way above target [on inflation]. To start talking about cuts it seems way premature,” said Reis, adding that FOMC officials might instead consider a greater sense of urgency in bringing inflation back to target, which the latest Fed forecasts only envision occurring in 2025.

“Are we happy with inflation at 2% in 2025, or should we be very nervous about that and say, no, we really want to bring inflation down to 2% by the end of 2024?”

OPTIMISTIC ON INFLATION

Despite his preference for additional tightening, Reis is optimistic about the prospects for inflation to extend its recent decline. Consumer price inflation rebounded slightly to 3.2% in July while core CPI dipped to 4.7%, data showed Thursday, still well more than double the Fed’s target.

Reis said a decline in inflation does not require a big spike in the jobless rate as some commentators have suggested. Still, while the chances of a soft landing have improved – from about 10% to 40% over the past year in Reis’ view – he still sees that outcome as not the most likely. (See: MNI INTERVIEW: US Disinflation In Train But Economy Overheated)

“The idea that we do this massive hike and get zero sacrifice ratio – it would be incredible,” he said. “I continue to be among those who think it’s unlikely. I’m very happy to be wrong.”