MNI INTERVIEW: US Growth Too Firm For Fed To Hit 2%-Blanchard

The economy and job market are likely still too strong for the Federal Reserve to be able to begin cutting interest rates soon, and additional hikes, while not the baseline, cannot be ruled out, former IMF chief economist Olivier Blanchard told MNI.

Most of the downward move in inflation since its 2022 peak was due to relative price shocks fading, said Blanchard, who recently published new research with former Fed Chair Ben Bernanke entitled “An Analysis of Pandemic-Era Inflation in 11 Economies.”

“What remains is pressure from the labor market, which has been tight,” he said in a telephone interview from France. “Expectations of inflation have increased a bit and so wage growth is a bit higher than it should be if they want to go back to 2%.” (See MNI POLICY: Stubborn Wage Growth Too High For Fed's Comfort)

Monetary policy is probably restrictive, Blanchard said, but it is pushing against the strong tailwinds of a service-led post-Covid economy aided by ample fiscal stimulus.

“The fact that we don’t see much (effect) on the unemployment rate doesn’t mean monetary policy is not working, it just means it’s fighting something very strong. I have no reason to doubt that monetary policy works. It is clearly fighting something that has to do with extremely generous fiscal policy,” he said.

TOUGH SLOG

That means getting all the way to 2% could well take more of a slowdown in growth than Fed officials currently anticipate, because most of the sharp decline in inflation from its peaks was due to fading relative price shocks related to the supply chain and the labor force.

“The question is, do they need to increase rates? “It is not inconceivable. I don’t think that’s the baseline,” said Blanchard, a senior fellow at the Peterson Institute for International Economics. (See MNI INTERVIEW: Fed's Next Move Could Still Be A Hike-Posen)

“Maybe they want to give up on the 2% at least for a while and let the economy continue. The assumption still has to be that the economy has to slow down a bit and interest rates will decrease only slowly is my best guess.”

WALLER WINNING

One caveat includes the possibility that stronger productivity growth might accommodate robust employment without generating inflation. Yet Blanchard remains skeptical that price pressures will continue to ebb if growth and jobs can stay as strong as they have.

He concedes that Fed Governor Chris Waller has thus far won a long-standing debate, in which Blanchard had taken the other side, over how much inflation could come down without sparking much of a rise in the unemployment rate. Waller had argued the job market’s rebalancing would come primarily from a decline in openings, which indeed have now fallen to their lowest level since 2021.

But Blanchard still believes something more substantive might have to give on the employment front in order for the Fed to get all the way down to its target in a timely manner.

“It’s going to be a long process. It will take some slowdown of the economy,” he said.